Wednesday, February 4, 2009

Executive Compensation: Obama is not an Economist

Obama set an executive pay limit on bailout recipients today.

While that "feels" very fair, it may ultimately be pandering to the public's hatred of Wall Street at the expense of the long term health of the US banking system. I wrote this immediately after the John Thain compensation scandal:

Say what you like about paying executives who get companies INTO crises, but the following is an argument for why CEOs who take over in the middle of crises, like John Thain, should get paid:
Making a turnaround work requires very talented management, which John Thain, by most accounts, is (he never got Merrill into that mess, but he took over and basically saved the company and most of its employees by engineering an impressive deal with BofA).

Being a CEO of a large company is usually a chance you only get once, and even if you do get a second chance it's usually much, much later, which means taking on the CEOship of a turnaround can be a huge career risk. If you need talented management for a turnaround to work, and talented management actually are interested in a successful career as a CEO, then getting talented management requires significant personal reward above what they could get in a safer setting to offset the substantial personal risk they're taking. CEOs in safe settings are paid a lot in the US, rightly or wrongly (I'm not arguing this either way), so to get a CEO to take a risky setting requires even more.

By limiting corporate compensation in a turnaround setting, you typically ensure your CEO candidates will be of a type that is either a) unable to get a better job now or in the near future (i.e... nobody regards them as that good) or b) your candidate will have grown up inside the company and have acquired enough stock and personal reputation in the company to make turning the company around worthwhile to them even in the absence of a salary. This typically means they've been around during the gross mismanagement and may not offer the fresh insight required for a successful turnaround.

If the government is investing bailout money and there's no insiders who are regarded as talented enough to take on the CEOship, the government should want the bailout to succeed, and offering a salary competitive on a risk/reward basis with the other opportunities available to talented potential CEOs is the best way to do that. (Detroit, take note).

edit: Couldn't agree more with this:


  1. Duly noted. But a cap on executive compensation could also help incentivize CEOs to get their banks off the government dole sooner, rather than later.

    And while your economic/business argument is sound, there is something to be said for the moral and ethical argument here. Is it really right for bank executives to be taking home millions of dollars in compensation, when the only reason their companies are still alive is because of taxpayer dollars? When thousands of other people are losing their jobs as a result of an economic downturn caused at least in part by the reckless investment strategies pursued by those banks?

    I'm not convinced it is.

  2. The point about getting CEOs off of government support sooner rather than later is a fair one, but you could quite easily do that by placing time limits on when the bailout money gets paid back or accelerating the interest rate over time.

    I don't agree with the moral and ethical argument because I don't see good executives getting paid as the bad here; it's employees being laid off who wouldn't be if executive pay were reduced that I see as the bad.

    If the latter situation occurred, then the manager is taking money while his employees suffer. However, if offering executives exorbitant pay ultimately saves more jobs through more competent management than redistributing that pay to workers or reducing layoffs, then the moral and ethical argument falls down - I know it doesn't feel warm or cuddly, but everybody's better off in the end.

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  4. Companies needing a bailout need to attract talent. Capping compensation does not attract talent (perhaps drives them away). So these companies are getting doubly hurt, i.e. capping compensation makes the problem worse.