Thursday, February 05, 2009

Executive Salary Caps? Asinine

As far as I am concerned, President Obama has made his first major policy error yesterday by announcing  a salary cap of $500K per year for executives in companies that have received "exceptional assistance" from the government. Sure, $500K is a huge amount of money and many of us would love to earn much smaller amounts. Nevertheless, President Obama's decision is simply asinine. No, it's not that I feel bad for fat wall-street cats who have managed their companies into the ground. Not at all. But Obama's policy is a populist, over-reaction that is bound to have some serious adverse consequences. 

Wall street pays its employees outrageous amounts of money. You can argue about whether these sums are well deserved or even rational. Personally I think that if someone brings in a deal worth hundreds of millions of dollars for his firm he should be VERY handsomely compensated. Compensation should be tied to the value that you create for your firm. Be that as it may, this has nothing to do with the argument at hand - the real problem with the salary cap is that it hobbles firms that have received government assistance and puts them at a disadvantage compared to firms that did not receive such assistance.

For example, assume for a minute that I am a killer rain-maker for Citigroup. I bring in deals worth hundreds of millions of dollars a year, and I have been accustomed to getting obscene amounts of money for my services. Now, due to no fault of my own, my firm is in tough shape and has asked for government assistance. It is now subject to salary caps and cannot pay me those crazy amounts. As a rational employee - who is trying to protect his own interests - the first thing I do is pick up the phone and call recruiters at competing banks that did not receive such government assistance. I ask for a job, explaining that I could bring in huge deals with me. Do you think that Citigroup will be able to retain fictitious me for a "paltry" $500K when Credit Swiss, HSBC or some boutique bank somewhere will pay me 10 times that amount? Nope. Obama's populist decision has just doomed banks that have received government assistance to mass defection of all top talent. It's like telling only one NBA team that they must recruit no-one over 5'10". 

Well, "damn those banks" you say. They deserve to lose their talent. They deserve to go out of business. That may very well be the case - but if so, why bail them out in the first place? What's more, here something truly stupid: we are dooming these banks to further loses AFTER we have put tax payer money at risk to save them. Could there be a more counter-productive policy?! We are now large shareholders in these banks and we have just decided to handicap only our team...

I am as outraged as the next guy at the mess we're in. However, policy of this nature creates much bigger problems than it pretends to solve. If you want salary caps, they have to be implemented industry-wide, or else you are simply squeezing a balloon: you press one end and the air escapes your hands and flows to other parts. You want real results? Let shareholders, rather than the board of directors, have the authority to approve the compensation packages of senior executives. You want to punish poor performance? Outlaw golden parachutes for executives fired from corporations that took government aid. Don't penalize tax payers by screwing up companies we just spent billions of dollars to rescue. This is exactly why government should not be running businesses. There's no common sense there, only pandering to rightfully outraged voters. 

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Joshua said...


JMHO said...

Even though I am a fan of free market capitalism, I am not sure I disagree with a few rules that eliminate or prevent fraud.

I believe the intent of the rule was to eliminate bonuses or rewards for bringing cash regardless of their quality or risk. Theoretically, by replacing the cash payment with some kind of the stock compensation, it would ensure that the revenues brought in do not create long term toxic effects. If they do, the stocks get hurt and no one gets a bonus. I believe this forces the industry to do a better job of risk management and creates a pay for performance system. I think regardless of this rule, the industry has been fundamentally changed, everyone will now question the fees, risks and returns and hopefully it will translate to a more transparent industry.

Shadox said...

JMHO, the cap is not about eliminating frivolous bonuses, it is about instituting a simple salary cap under the assumption that companies who receive support from the government should not be wasting this money on so-called wasteful activities.