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  • Unintended Consequences on Executive Pay II: Pay Caps

    Policies premised more on class-warfare than sound economics, are not going to get us out of this recession. They may actually delay recovery.

    In my last post, I discussed the example of a ban on “golden parachutes” for top executives. Now, another item from the Treasury’s pay rules for companies receiving “extraordinary assistance” that may soon be foisted on the broader market: executive pay caps.

    The rule is short and sour: Senior executives can receive no more than $500,000 in total annual compensation. They can also receive restricted stock that has no value until after the government loans have been repaid.

    The result: once again, unintended and counterproductive consequences that will sap incentives for economic growth.

    First, let’s get something out of the way here: $500,000 per year, while a large amount, is hardly extravagant. Think: Is someone like Steve Jobs at Apple worth that much? The market seems to think he’s worth billions to the company. Annual compensation of $500,000 or more is not outrageous in every case. It depends on the situation.

    And it’s not far-fetched at all that some executives bring much more than $500,000 in value to their companies—and now, especially, when we’re desperate for economic growth, hopefully much, much more!

    But the government’s rule brooks no exception.

    Thus firms subject to the rules won’t be able to pay for big talent—those exceptional individuals who really are worth the big bucks. Law professor Larry Ribstein suggests that the cap could “hasten the flight of talent” out of Wall Street firms and into private equity partnerships, where the earnings are limited only by results. The first to leave, of course, will be those worth the most money—that is, the most talented. That’s not good news, especially for the corporations that have needed “extraordinary assistance” and now need extraordinary performance. As Ribstein puts it, “These are the executives and companies for which incentive pay is most important.”

    And even if the brilliant types stay on at lower pay, they may not put their all into their work. After all, once you’ve maxed out compensation for the year, why bother putting in 12-hour days and working weekends?

    One way to get around these problems is to get around the rules. In other words, provide perks, lots of them, so that effective compensation is far higher than reported compensation. Executive jets, for now, are off the table, but personal assistants, cars and drivers, and many other luxury trappings are still game. But all these things are less efficient than just paying compensation, so they will cost companies and their shareholders more. Even worse, perks aren’t a perfect substitute for a carefully crafted compensation agreement that aligns an executives incentives with shareholders’. So if the caps don’t strictly hold, the net result could be higher expenses and, yet again, poor performance.

    Finally, John Carney points out one additional consequence for the financial industry (though it may be more broadly applicable): the end of job-exit as a signal. In economics, “signaling” is how individuals convey information to others, often through their actions. For example, a college degree signals to employers that you’re likely to be a good worker. On Wall Street, talent walking out the door signals that your firm is in big trouble. But with pay caps, there’s little reason to exit so swiftly. Some corporations might take advantage of this state of affairs to take big risky bets. And when a business really is in dire straits, there will be a longer lag before it comes to light, making it harder for investors to judge that business’s health. That won’t help the investment markets one bit.

    Again, class warfare is no substitute for good economic policy—indeed, the two are often precisely opposed.

    Posted in Economics [slideshow_deploy]

    16 Responses to Unintended Consequences on Executive Pay II: Pay Caps

    1. Barb -mn says:

      Mr. President, I know it may be difficult for you to understand that government is the obstacle in the country’s ability to prosper again. It may be difficult for those in government who have depended on government some or all their lives. Whether it be by employment or free handouts or both.

      Qualification to presidency of a free country should be one that has lived free all their lives. No government handouts…that’s true freedom. Once you experience FREEDOM, you learn to respect it.

      To be accountable builds integrity. To admit your failures to your responsibilities makes you a man.

      Learn what your duties are in a free country, Mr. President, you’re stepping way over the line. Stay out of the private businesses of others unless it is in violation to the safety of America and her people. Thank you

    2. Jim Hutchens says:

      To answer the question is Steve Jobs at Apple worth billions,no way! There is not a man or women walking this earth worth billions to do a job.I have never made the "BIG BUCKS"and I do not believe the guys setting at the top should be making the multi million multi billion dollar bonuses. We the little people put in our 12-14 hour days so we can hit our deadlines so the big guy looks good.

      what I have been reading is the CEO, CFO and Presidents who have not kept there companies on track and profitable,they are bailing out with million dollar bonuses.I thought the boards of these companies were to keep track of how the company was doing. If they were not profitable then no bonus should have been allowed.No wonder these companies don't make money they pay it out in bonuses

      I believe everyone of these companies that are asking for bail out money should bring back the executives that got large bonuses and then bailed out, should be brought back and require the bonuses be paid back. Maybe then they wouldn't require as large of a bail out. If they don't pay it back then they spend time in prison.

      If bail out money is need to replenish what was paid out in bonuses I believe fraud is involved

    3. Marcus McIntire says:

      I agree with Mr. Grossman’s article. However, I believe he didn’t go far enough. What country is this happening in? Was it Cuba, France or Russia? No, this socialistic compensation cap happened right here in America, a one time free market capitalist economy. This is only the first step in a far left agenda that our new president and 111th congress plan to push down our throats. Keep in mind, President Obama has only been in office 15 days. So far he has promised to close Gitmo and give the detainees constitutional rights, taken away the statute of limitations of discrimination on equal pay lawsuits, expanded the S-CHIP program to children of illegal immigrants, promised to cut or nuclear weapons by 80% and not move forward with missle defense along with capping executive pay. I believe that we will be lucky to recognize this country after 4 years of these types of policies.

    4. Marcus McIntire, Kansas City, MO says:

      I agree with Mr. Grossman’s article. However, I believe he didn’t go far enough. What country is this happening in? Was it Cuba, France or Russia? No, this socialistic compensation cap happened right here in America, a one time free market capitalist economy. This is only the first step in a far left agenda that our new president and 111th congress plan to push down our throats. Keep in mind, President Obama has only been in office 15 days. So far he has promised to close Gitmo and give the detainees constitutional rights, taken away the statute of limitations of discrimination on equal pay lawsuits, expanded the S-CHIP program to children of illegal immigrants, promised to cut or nuclear weapons by 80% and not move forward with missle defense along with capping executive pay. I believe that we will be lucky to recognize this country after 4 years of these types of policies.

    5. SID SANDBERG, PROVO, UTAH says:

      Shameful, President Obama called the payments made to certain executives shameful. Obama said he did not want to punish Joe the plumber for his success, he does however, intend to punish these executives. These are the executives who dealt with the consequences of making government mandated loans to high risk borrowers. Maybe these executives prevented an even greater financial disaster. The government created the mess, maybe the government should help clean it up. Do not forget, Obama is a socialist, fear mongering and class warfare are the tools of the socialists. When these executives leave, maybe Mr. “I screwed up” can hire more tax cheats like Daschle and Geitner. Shameful? Cabinet nominees and appointees like these, now that is shameful.

    6. Kelly, Castle Rock C says:

      Can you say Atlas Shrugged? These days, it shouldn't be in the fiction section…it should be in non-fiction!!!

    7. Keith, Warrensburg M says:

      I don't like government dictating salary caps however, whatever it takes to put a stop to the insanity of corporate welfare, ie stimulus, then I am for.

      If some executive wants my money why should he or she be making more money than me?

      I believe exhorbatant salaries are a disgrace in any case. I do not believe anyone is worth a million a year. A person is where they are by circumstance more than anything else. Take a typical man or woman off the street and they can CEO with the best of them.

      Given of course they have common sense which these days seems less common the higher on the food chain one climbs!

      Especially politicians!

    8. Dave Hiltbrand, Weat says:

      I have long been of the opinion that most of the U.S. executives are overpaid. Their salaries and bonuses are established by Boards of their peers, a rather incestous system. And their total compensation typically far exceeds that of comparable foreign competing companies. However, the government has never and will never be smart enough to know what justifiable compensation is either. The failure of stockholders to perform their duties and vote consistently to hold executives and boards accountable and reasonable is the problem and as is typical of human nature. As long as the stock prices are going up, we sit back, fat, dumb, and happy to let the status quo proceed untouched. Only when the stocks crash do we ask for accountability. Just look at Enron, no one complained or even wanted to ask about questionable activities when the stock was soaring because they were also benefitting. When the truth became known and justice prevailed, the just-as-greedy-but-on-a-different-level, previously apathetic stockholders became morally outraged, how-could-this-happen company owners.

      Of course as with every story, there is blame to go around everywhere. Government regulators are expected to provide the oversight to protect the common man from corrupt business practices. Company executives and boards are supposed to look out for the "long-term" interests of the stockholders, not short-term soaring stock prices that bring them inordinate bonuses. And, stockholders are supposed to be responsible company owners and follow the activities of their companies. Likewise, voters get what they vote for, Democrats who bring home the pork and move us closer to socialism or Republicans who bring home a different pork and move us closer to socialism.

      Two things have become very clear with this latest economic mess. First, government cannot be omnipresent, omniscient, or even trusted to protect us from everything that can go wrong or that can be corrupted in the private sector. In fact, government can be corrupted just as easily, maybe more easily, as the private sector. And second, and probably most important, unless the people of this country get up off of our lazy, blame-the-other-guy butts, take action, and start behaving responsibly, ethically, morally, and legally, we can never expect our leaders (both public and private) to behave any better and put the country's and people's interest ahead of their own.

      Bottom line, if government starts to establish fair compensation for executives, look out, you're next!

    9. BruceJ, Tucson Arizo says:

      Actually, Steve Jobs is paid exactly $1, the same annual pay he's taken from Apple since he was appointed interim CEO in 1996.

      http://tinyurl.com/bs4lh3

      He has perks, and stock options, but his pay as CEO, while managing an almost unheard-of turnaround at a company that has since been consistenly more profitable than just about any other company in it's category, has been $1 a year.

      Most of his wealth comes from the OTHER enormously successful and profitable comany he owed, Pixar, now part of Disney.

      No one would object in the slightest if these executives were performing in accordance with their stratospheric pay; but the truth is, if I failed as miserably in MY job as they did in theirs, there would be no issue with my pay, either, as it would be $0, because I'd be out on my ass.

      There's a simple solution to this problem. If these executives do not want their pay capped…they don't have to take taxpayer money.

    10. Dan K. Minnesota says:

      If the president thinks it is okay to cap these salaries, because of goverment support, shouldn't the government also limit the salaries of athletes, professional team executives, college presidents, college sports coaches, government consultants, etc. The presidents stated earlier this week that we can't have one group in society with different rules to live by, so Mr. President let's see you put these rules to all who have benefitted from the peoples taxes.

    11. James Andersen, Nort says:

      Marcus McIntire wrote,"this socialistic compensation cap happened right here in America, a one time free market capitalist economy. This is only the first step in a far left agenda that our new president and 111th congress plan to push down our throats."

      Mr. McIntire, Is right in one respect, this is only the first step in a far left agenda. This Congress has but one goal and that is to implement as many Socialistic policies as they can during the short time they will have control in Congress.

      However, I disagree that the United States has ever had a truly free capitalistic economy. If we study our history we find that Congress has always passed legislation favorable to BIG BUSINESS and rarely takes the side of the working man. When pushed to legislate against industry we get vague, weak legislation like the “Sherman Anti-Trust Act” that took thirty years and a strong, popular President before any Trusts and monopolies were broken up.

      As fun as a history lesson would be here, I think we need to get on topic. I do not have a problem with President Obama limiting Executive Pay. If they want to argue that it goes against the free market idea and undermines capitalism, then they should not have asked for or taken government money. Capitalism works on the idea that the strongest will survive. If a company makes bad decisions and wastes money then they are destined to fail and if we are truly capitalists I say let them fall; someone else will rise to take their place.

    12. David Dzidzikashvili says:

      I think it was a right decision to limit CEO salaries at 500K for the companies that are getting taxpayer money. In general I strongly disagree with government intervention in private business matters, but since these companies are utilizing my money and your money and the money that belongs to all Americans, we have the right to limit their payroll, especially after the embarrassing facts of CEOs using bailout money for lavish parties, private jets and unreasonable bonuses. Once they pay us back the money owed, they can have all the bonuses and salaries they want.

    13. Rene, IN says:

      The cap may seem extreme, but it is only for companies that need to realign. What about the employees. The one person at the top usually makes more than 50% of the company employees…COMBINED. The cap is a great place to start when companies are screaming about going out of business and the workers are giving up their health insurance while the big guy at the top is losing a few million. Boo freakin hoo.

    14. Barb -mn says:

      It is not the governments business to cap any private business. Obama and the clan need to CAP THEIR OWN. GOVERNMENT IS PAID HIGHLY TO DESTROY THIS COUNTRY. AMENITIES COVER THEIR LIVING EXPENSES.

    15. Aaron PA says:

      Firstly, when I was reading the original post I completely agree with the comment about how $500,000 is a very arbitrary cap on CEO pay, especially with different company sizes.

      For instance, a large company odviosuly would pay their CEOs more and a cap not dependent on company size would just give a pay advantage to smaller firms who take bailout money. If anything, a certain percent of the companie's size should be the limit to a ceo sallary.

      With that being said, I would rather there was no CEO cap then the current system. I do feel that an ideal cap system would be better. I do disagree with most of the other points in the post. The responce is very partisan and doesn't bring up the other sides of the issue.

      In this economic times, where "experienced" government, and business workers caused this problem, it is crucial that we get new blood into the system. Even if a cap on CEO sallary will restrict the most experienced CEOs, the experienced CEOs in other companies that do not need bailout will not be capped. Getting a bailout is a clear indication of a poor strategy of the business, which means that they need new thinking.

      During these times, when other CEOs are willing to recieve $1 untill times improve, the incentives to help your company are much greater then during good times. Even if there is some reductions in incentives from inneficent payments to CEOs to avoid the rule, compared to sallaries of CEOs those are minimal. The incentives during this crisis increase because CEOs do not just work to get increased pay, but to actually keep their company (and their job afloat).

      There is also the issue of how some free market systems aren't present in determining CEOs anyway. Potential CEOs who are willing to be a CEO for a lower price are not able to bargin when another CEO is determined. A CEO is FIRST chosen by the board, who then determine the sallary. It is impossible for a perspective CEO to say that they would do that work for a lower price.

      "Tax revolt" is also an important issue to be taken into account. Even if that can just be percieved as populist rantings that don't effect the economy, it is still important. The economy is based on people's confidence, and people may be less confident in their system if they feel that their money is being wasted. If someone does believe in the bailouts, then it is unlikely that they would continue from fear of backlash if CEO pay isn't capped.

      Of course, intervention into the economy will normally inherently scare investors, so that is still mixed. And investors are theoretically one of the best determinors of the strength of the market. I am curious what turn the stock market did when CEO caps were first brought up.

    16. Pingback: Morning Bell: President Obama’s Foundation of Straw | The Foundry: Conservative Policy News.

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