The foolishness of populist fervor for CEO pay cuts
Populists left and right are supporting "Pay Czar" Kenneth Feinberg's slashing of the pay of top executives at 7 companies that have been propped up by a ton of taxpayer bailout money by about 90% as well as rules for those firms that are designed to incentivize long-term success by making sure that, for instance, stock-linked compensation is pegged to long-term stock performance, presumably to avoid short-term risks that promise a quick buck by piling on long-term systemic risk. That left-leaning folks would support any move to slash CEO pay is unsurprising, but that folks who are generally in favor of a free market are on board with this is a bit more surprising, although not particularly hard to understand.
Bill O'Reilly gave the typical conservative populist justification for this move in a discussion with Neil Cavuto, whose concerns about a slippery slope were dismissed by O'Reilly as paranoid and misplaced. The conservative explanation generally goes something like this: these executives' companies were saved by the government and therefore the taxpayers are essentially the ultimate shareholders and the government is sort of a super-board of directors that looks out for those ultimate shareholders. By making sure that money isn't wasted by paying these executives the gaudy sums of their non-government-money owing counterparts at other firms the government is ensuring that these firms run lean and mean and get paid back more quickly. The reason a conservative like O'Reilly supports the move is that he doesn't want to see taxpayer dollars squandered by lining the pockets of fat cat executives, who by inference, when they work for other firms that are not subject to government regulation, are compensated to a degree that is essentially 10-fold greater than what their performance justifies.
Goldman Sachs's notable success, its many powerful alumni in positions of public service, often regulating both their friends and former competitors (e.g. John Corzine being a Senator and Governor and Hank Paulson being the head of Treasury) and its receipt of public money (both as one of the 9 banks forced to take government capital to shore up public confidence during the crisis last fall and as a very large creditor of AIG) all mean that it is the poster child for the greedy, corrupt, firm whose executives are paid too much because of a friendly system whose rules they control. Despite being held up as one of the worst offenders against any form of social conscience, but having paid back its government obligations, Goldman is more or less back to business as usual both in terms of its business operations and more pertinently to why they're being vilified, in terms of compensation for top employees of the firm. After 2008 when they paid out very little (relative to other years) in base comp and no executive bonuses (they were holding TARP cash at the time) they will be back to paying out millions upon millions in comp for top execs this year with big bonuses too after a boom year for the firm where their stock gained ground amid a bull market. One can see why this situation pisses people off: who decides how much Goldman execs get paid? Goldman execs. The fox doesn't just guard the henhouse... he runs it.
The thing is that Goldman Sachs has been a publicly traded company for a decade now, and it while its top execs are still called "partners" the name is purely symbolic: the company is publicly traded and ultimately the "partners" are not a small group of owners who can act without oversight, but rather they act with the oversight of a board of directors and ultimately the votes of their shareholders. The situation is complicated by the fact that Goldman's IPO was so recent that some larger than normal fraction of shares are held by current or former Goldman execs, but in general at other large companies like Morgan Stanley and dozens of other huge corporations that have been publicly traded companies for a long time, the number of shares that are in the hands of people who don't work for the company is generally the large majority. If the route to profitability were to slash executive pay it seems like that plan would have been pushed for by shareholders at one of the hundreds of institutions set up in this fashion, doesn't it?
And yet there has never been a successful shareholder push at a major publicly held company, even on Wall Street, in the wake of this most recent financial crisis, which in the popular narrative was caused by the incompetence of these well paid plutocrats, where a company's shareholders to voted to slash executive compensation in a manner even remotely similar to the government plan. If it made sense though, you'd think shareholders would be all for this; money not paid out in compensation, especially at a firm without any significant capital costs like a financial firm, would be essentially pure profit and could be distributed to the shareholders as dividends. Yet even as income inequality has risen, the income of the very top portion of earners has exploded, examples arose of extremely dire consequences being the result of decisions made by well-paid, strongly recruited chief executives, still no company took this route. Many of the firms that were run by these very well paid individuals either took a big hit in earnings and market capitalization, had to be saved by government intervention, or went completely belly up, and yet shareholders at GS, Morgan Stanley or any of the hundreds of other corporations in other sectors fail to see the wisdom of demanding that their employees be paid 10% of what they have previously been paid.
Having known many Yankees fans who were generally left leaning, I find it somewhat surprising that for some reason most people I've met who oppose the discrepancy between the pay of say, a chief executive at a large manufacturing corporation and the pay of a blue collar worker at that same company have ever complained to me about the discrepancy of the pay between the players on the Yankees and say, the food vendors at Yankees Stadium. Now I have no problem with this discrepancy; I recognize that the ability to play baseball at the level of a Major Leaguer is an incredibly rare skill. Ironically, of course, their skill is at playing a trivial game, but since millions of people enjoy watching that game and will pay for the privilege, their skills generate wealth and improve the quality of the lives of people who happily exchange hard earned money for game tickets, Yankees caps, etc. But perhaps it is merely because people intuitively understand that Alex Rodriguez's ability to hit a baseball is exceedingly rare it is the reason that they do not complain that he is paid tens of thousands of dollars per hour of game time. They understand that the idea that the Yankees would try to slash costs to improve their team is ludicrous. As in real life, in Major League Baseball, human capital is mobile; an inability to pay people well will lead to a lack of talent (see the consistent failure of teams like the Pittsburgh Pirates that chronically cannot pay as well as the Yankees) and people interested in seeing the Yankees be successful on the field and at making money obviously think that their massive payroll to get and keep top talent is justified.
In the realm of finance, it seems, people are under the impression that CEOs are replaceable, a dime a dozen, interchangeable, and that systems of evaluating and pricing talent in positions of crucial importance for the success of the organization are disconnected from incentives like seeing the firm succeed or control risks. But just as sometimes the Yankees misallocate large amounts of payroll (see Carl Pavano) and such examples and tales of golden parachutes on Wall Street show that such systems are obviously imperfect and sometimes absolutely wrong, and just as the Yankees don't always win the World Series just because they pay their players several fold more than most other ball-clubs, that doesn't mean that the entire premise of incentivizing performance with pay is flawed.
For now, the fate of these 7 firms will be interesting to watch; as financial wards of the state the mobility of their top executives and the autonomy of decision-making of the firms' employees both in staying or leaving and in day to day operations is unclear; it would seem to me that the best executives, who suddenly find themselves being compensated for the foreseeable future at a level that a competitor could easily double, triple, or increase nearly 10-fold, would jump ship if they could. If they can't, their incentive to try to rise up within the organization and put forth the extraordinary effort of the stereotypical workaholic businessman glued to his blackberry seems like it would only be to maintain their reputation so that their pay will increase relative to past levels once they can either be paid in the old way by their firm once they're out from under government regulation or once they can leave their current firm.
So at best there are reasons for the best workers to try to leave the firm, for other firms to poach talent at bargain basement prices, and only weak incentives to continue putting forth full effort that would increase profits and get the taxpayers their money back that are contingent on the idea that their pay will someday be back to near what it would have been. The automakers regulated under this plan can be discounted; they will never be profitable for reasons unrelated to executive compensation. But the performance going forward of Bank of America will set a bad precedent no matter what happens; if the pay cuts decrease the quality of employees or the quality of their work then capital will flow out of the firm, the firm will be less profitable, and taxpayers will wait longer to get their money back. Further, if there is a massive flight of talent from these firms then the incentive for the government will be to somehow level the playing field and limit executive pay more broadly. If the firms exceed expectations then the government will be emboldened to curb CEO pay more broadly and more worrisome, the model of a firm "too big to fail" seems like it will be proved viable and government will inextricably become more intertwined with business.
The latter scenario seems very hard to fathom, however, and I doubt that this experiment will do anything but prove that while imperfect and probably permeated by a significant fraction of misses, the system of rewarding outstanding performance abilities held by a limited number of highly talented individuals with a a very rare skill with outstanding compensation will be vindicated. While no one questions that Alex Rodriguez has a very rare skill that is therefore worth very high compensation in a free market, seeing why some white guy in a suit is so special is less easy to accept; if it weren't him it would be somebody else, it seems, but the number of individuals with the intelligence, experience, leadership and interpersonal skills to successfully create business strategies for an extremely complex business like an investment bank that deals with billions of dollars daily is few, and those who do so successfully must be compensated well to maintain competitiveness in a global marketplace. While there will be unsuccessful individuals and they should be sacked, while it's no more fair than the gaudy sums that Alex Rodriguez is paid for playing a children's game very very well, you should be paid a competitive rate if you possess the ability to successfully helm a company that facilitates trillions of dollars of global capital flows in a given year and creates massive amounts of wealth for those who work for the firm and, in the case of say, a successful investment bank or fund management firm, for the businesses who are their clients or the investors who trust them with their money, often including large institutional investors such as state or union pension funds.
Is it justified? It depends. But while money talks, it also walks these days. If the U.S., for instance, were, hypothetically, I stress, to cap CEO pay, it seems likely that foreign firms like UBS and Deutsche Bank would feel that the skills of the executives at competing firms like Morgan Stanley and Goldman would be valuable enough that they would pay them a large amount of money to jump ship. It's like the Yankees and Red Sox, now, but we could make it like the Yankees and Pirates. Why we would think that would be the way back to competitiveness, I have no idea.
One final comment, to paraphrase a quote from the man behind this decision to cut CEO pay at these government indebted firms, Special Master for compensation Kenneth Feinberg, he says he doesn't want to be called the Pay Czar because that suggests imperial powers whereas his job has involved months upon months of negotiations and meetings and haggling and this number and plan were reached in a process that resembled a negotiation. There's only one problem. The final decision rested in the hands of one Kenneth Feinberg, and while the companies can appeal this decision, the appeal goes to... Kenneth Feinberg. That sounds like an imperial power to me, no?
Who is John Galt?
Bill O'Reilly gave the typical conservative populist justification for this move in a discussion with Neil Cavuto, whose concerns about a slippery slope were dismissed by O'Reilly as paranoid and misplaced. The conservative explanation generally goes something like this: these executives' companies were saved by the government and therefore the taxpayers are essentially the ultimate shareholders and the government is sort of a super-board of directors that looks out for those ultimate shareholders. By making sure that money isn't wasted by paying these executives the gaudy sums of their non-government-money owing counterparts at other firms the government is ensuring that these firms run lean and mean and get paid back more quickly. The reason a conservative like O'Reilly supports the move is that he doesn't want to see taxpayer dollars squandered by lining the pockets of fat cat executives, who by inference, when they work for other firms that are not subject to government regulation, are compensated to a degree that is essentially 10-fold greater than what their performance justifies.
Goldman Sachs's notable success, its many powerful alumni in positions of public service, often regulating both their friends and former competitors (e.g. John Corzine being a Senator and Governor and Hank Paulson being the head of Treasury) and its receipt of public money (both as one of the 9 banks forced to take government capital to shore up public confidence during the crisis last fall and as a very large creditor of AIG) all mean that it is the poster child for the greedy, corrupt, firm whose executives are paid too much because of a friendly system whose rules they control. Despite being held up as one of the worst offenders against any form of social conscience, but having paid back its government obligations, Goldman is more or less back to business as usual both in terms of its business operations and more pertinently to why they're being vilified, in terms of compensation for top employees of the firm. After 2008 when they paid out very little (relative to other years) in base comp and no executive bonuses (they were holding TARP cash at the time) they will be back to paying out millions upon millions in comp for top execs this year with big bonuses too after a boom year for the firm where their stock gained ground amid a bull market. One can see why this situation pisses people off: who decides how much Goldman execs get paid? Goldman execs. The fox doesn't just guard the henhouse... he runs it.
The thing is that Goldman Sachs has been a publicly traded company for a decade now, and it while its top execs are still called "partners" the name is purely symbolic: the company is publicly traded and ultimately the "partners" are not a small group of owners who can act without oversight, but rather they act with the oversight of a board of directors and ultimately the votes of their shareholders. The situation is complicated by the fact that Goldman's IPO was so recent that some larger than normal fraction of shares are held by current or former Goldman execs, but in general at other large companies like Morgan Stanley and dozens of other huge corporations that have been publicly traded companies for a long time, the number of shares that are in the hands of people who don't work for the company is generally the large majority. If the route to profitability were to slash executive pay it seems like that plan would have been pushed for by shareholders at one of the hundreds of institutions set up in this fashion, doesn't it?
And yet there has never been a successful shareholder push at a major publicly held company, even on Wall Street, in the wake of this most recent financial crisis, which in the popular narrative was caused by the incompetence of these well paid plutocrats, where a company's shareholders to voted to slash executive compensation in a manner even remotely similar to the government plan. If it made sense though, you'd think shareholders would be all for this; money not paid out in compensation, especially at a firm without any significant capital costs like a financial firm, would be essentially pure profit and could be distributed to the shareholders as dividends. Yet even as income inequality has risen, the income of the very top portion of earners has exploded, examples arose of extremely dire consequences being the result of decisions made by well-paid, strongly recruited chief executives, still no company took this route. Many of the firms that were run by these very well paid individuals either took a big hit in earnings and market capitalization, had to be saved by government intervention, or went completely belly up, and yet shareholders at GS, Morgan Stanley or any of the hundreds of other corporations in other sectors fail to see the wisdom of demanding that their employees be paid 10% of what they have previously been paid.
Having known many Yankees fans who were generally left leaning, I find it somewhat surprising that for some reason most people I've met who oppose the discrepancy between the pay of say, a chief executive at a large manufacturing corporation and the pay of a blue collar worker at that same company have ever complained to me about the discrepancy of the pay between the players on the Yankees and say, the food vendors at Yankees Stadium. Now I have no problem with this discrepancy; I recognize that the ability to play baseball at the level of a Major Leaguer is an incredibly rare skill. Ironically, of course, their skill is at playing a trivial game, but since millions of people enjoy watching that game and will pay for the privilege, their skills generate wealth and improve the quality of the lives of people who happily exchange hard earned money for game tickets, Yankees caps, etc. But perhaps it is merely because people intuitively understand that Alex Rodriguez's ability to hit a baseball is exceedingly rare it is the reason that they do not complain that he is paid tens of thousands of dollars per hour of game time. They understand that the idea that the Yankees would try to slash costs to improve their team is ludicrous. As in real life, in Major League Baseball, human capital is mobile; an inability to pay people well will lead to a lack of talent (see the consistent failure of teams like the Pittsburgh Pirates that chronically cannot pay as well as the Yankees) and people interested in seeing the Yankees be successful on the field and at making money obviously think that their massive payroll to get and keep top talent is justified.
In the realm of finance, it seems, people are under the impression that CEOs are replaceable, a dime a dozen, interchangeable, and that systems of evaluating and pricing talent in positions of crucial importance for the success of the organization are disconnected from incentives like seeing the firm succeed or control risks. But just as sometimes the Yankees misallocate large amounts of payroll (see Carl Pavano) and such examples and tales of golden parachutes on Wall Street show that such systems are obviously imperfect and sometimes absolutely wrong, and just as the Yankees don't always win the World Series just because they pay their players several fold more than most other ball-clubs, that doesn't mean that the entire premise of incentivizing performance with pay is flawed.
For now, the fate of these 7 firms will be interesting to watch; as financial wards of the state the mobility of their top executives and the autonomy of decision-making of the firms' employees both in staying or leaving and in day to day operations is unclear; it would seem to me that the best executives, who suddenly find themselves being compensated for the foreseeable future at a level that a competitor could easily double, triple, or increase nearly 10-fold, would jump ship if they could. If they can't, their incentive to try to rise up within the organization and put forth the extraordinary effort of the stereotypical workaholic businessman glued to his blackberry seems like it would only be to maintain their reputation so that their pay will increase relative to past levels once they can either be paid in the old way by their firm once they're out from under government regulation or once they can leave their current firm.
So at best there are reasons for the best workers to try to leave the firm, for other firms to poach talent at bargain basement prices, and only weak incentives to continue putting forth full effort that would increase profits and get the taxpayers their money back that are contingent on the idea that their pay will someday be back to near what it would have been. The automakers regulated under this plan can be discounted; they will never be profitable for reasons unrelated to executive compensation. But the performance going forward of Bank of America will set a bad precedent no matter what happens; if the pay cuts decrease the quality of employees or the quality of their work then capital will flow out of the firm, the firm will be less profitable, and taxpayers will wait longer to get their money back. Further, if there is a massive flight of talent from these firms then the incentive for the government will be to somehow level the playing field and limit executive pay more broadly. If the firms exceed expectations then the government will be emboldened to curb CEO pay more broadly and more worrisome, the model of a firm "too big to fail" seems like it will be proved viable and government will inextricably become more intertwined with business.
The latter scenario seems very hard to fathom, however, and I doubt that this experiment will do anything but prove that while imperfect and probably permeated by a significant fraction of misses, the system of rewarding outstanding performance abilities held by a limited number of highly talented individuals with a a very rare skill with outstanding compensation will be vindicated. While no one questions that Alex Rodriguez has a very rare skill that is therefore worth very high compensation in a free market, seeing why some white guy in a suit is so special is less easy to accept; if it weren't him it would be somebody else, it seems, but the number of individuals with the intelligence, experience, leadership and interpersonal skills to successfully create business strategies for an extremely complex business like an investment bank that deals with billions of dollars daily is few, and those who do so successfully must be compensated well to maintain competitiveness in a global marketplace. While there will be unsuccessful individuals and they should be sacked, while it's no more fair than the gaudy sums that Alex Rodriguez is paid for playing a children's game very very well, you should be paid a competitive rate if you possess the ability to successfully helm a company that facilitates trillions of dollars of global capital flows in a given year and creates massive amounts of wealth for those who work for the firm and, in the case of say, a successful investment bank or fund management firm, for the businesses who are their clients or the investors who trust them with their money, often including large institutional investors such as state or union pension funds.
Is it justified? It depends. But while money talks, it also walks these days. If the U.S., for instance, were, hypothetically, I stress, to cap CEO pay, it seems likely that foreign firms like UBS and Deutsche Bank would feel that the skills of the executives at competing firms like Morgan Stanley and Goldman would be valuable enough that they would pay them a large amount of money to jump ship. It's like the Yankees and Red Sox, now, but we could make it like the Yankees and Pirates. Why we would think that would be the way back to competitiveness, I have no idea.
One final comment, to paraphrase a quote from the man behind this decision to cut CEO pay at these government indebted firms, Special Master for compensation Kenneth Feinberg, he says he doesn't want to be called the Pay Czar because that suggests imperial powers whereas his job has involved months upon months of negotiations and meetings and haggling and this number and plan were reached in a process that resembled a negotiation. There's only one problem. The final decision rested in the hands of one Kenneth Feinberg, and while the companies can appeal this decision, the appeal goes to... Kenneth Feinberg. That sounds like an imperial power to me, no?
Who is John Galt?
Labels: ballyhoo, baseball, economics, government, politics
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