Throwing Executive Salaries to the Mob
posted by Nate Oman
Things are shifting so rapidly that it is dangerous to talk about consensus, but there does seem to be consensus that the executives of institutions that may benefit from the unloading of toxic securities need to take some sort of a hit. Why? It seems to me that there are a number of possible answers, some of them good some of them not.
In a conversation at the school bus stop the other morning, I heard the suggestion that the financial markets were in trouble because the executives were sucking so much of the value out of market with their huge salaries. “How can some people get paid hundreds of millions of dollars,” one parent said, “and there still be money left to pay mortgages.” I bit my tongue, but this sort of talk is just mathematically ignorant. The securitized debt market is $13 trillion and the credit derivatives market is $64 trillion. A couple of hundred million dollars is chump change. Still it is important to realize that there are a lot of people out there who think like this, and they vote.
A similar but slightly different argument is that the executives are morally culpable for the meltdown. It is not that their salaries are big enough to move markets on their own, but rather that they made a lot of stupid decisions that are costing other people a lot of money and they ought to be punished. The argument here, I take it, is frankly retributive. There has been wrong-doing and it ought to be punished. Alternatively, it may be based on some notion of unjust enrichment. The executives are profiting from their malfeasance and ought not to be allowed to do so.
This argument may or may not hold water, but as Christine Hurt and Jeff Lipshaw have pointed out the ultimate problem here is not one of fraud and wrongdoing, but rather of bubbles — inflated asset prices and inflated expectations. There is a tendency for people to moralize what they do not understand. Assigning causation to evil doers is a mental shortcut that may make some sort of cognitive sense in face of complexity. It is not, however, always a good way of understanding the world. Of course, even if you don’t think that the current crisis was created by fraud or other intentional wrong doing, one might still believe that irrational exhuberence deserves to be punished or is a sufficent basis for unjust enrichment.
Finally, one might object to executive salaries based on the argument that their current structure encouraged firms to focus on short term gains at the expense of the long term. I am sympathetic to this claim, although I am not sure what the regulatory response ought to be. There are good reasons for performance based salaries and golden parachutes. There is a tendency in some of the commentary about this mess to romanticize the financial and corporate system that existed before the deregulatory revolution that began in the late 1970s. Going back to a world of management that was blithely indifferent to the ultimate performance of their firms so long as the executive perks kept coming and held on to power with a death grip in the face of investors bent on change and better returns may not be the innocent and bucolic world that it is painted in some of the punditry. Still, I am open to the idea that we could improve the way that markets handle risks by shifting the incentive structures of managers. I just don’t see much evidence that this is the kind of thing that the current proposals are aiming at.
The odd thing is that I think that the least compelling arguments for limiting executive compensation may actually provide the best reasons for doing so. As I’ve posted here before, I think that risks posed by bailouts includes not only the perverse economic incentives that they create but also the fraying of the social contract in support of market capitalism. Throwing executive salaries to the angry mob may not be such a bad idea for the long term health of the system. Indeed, given the news over the last week — happy soul that I am — I have a mind to take up a pitch fork myself.
September 26, 2008 at 10:35 am
Posted in: Corporate Law
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Responses (3)
A.J. Sutter - September 26, 2008 at 11:33 am
1. Apropos of “[T]his sort of talk is just mathematically ignorant. The securitized debt market is $13 trillion and the credit derivatives market is $64 trillion. A couple of hundred million dollars is chump change. Still it is important to realize that there are a lot of people out there who think like this, and they vote”: To say that it’s mathematically ignorant may be misplaced. It’s ignorant of the magnitude of the financial industry. And why should most people, or even most voters, be aware of that if they aren’t working in that industry or a student of it?
The fact that voters are ignorant of the staggering sums involved in the dervatives market, for example, is less alarming to me than the occasional polls of Harvard graduating classes revealing a dearth of grads who can correctly explain what causes the four seasons (q.v., e.g., http://www.learner.org/resources/series28.html). You and many of the rest of us who frequent this blog have some professional interest in this field, but I’m not surprised that corporate finance is a bit arcane and counterintuitive even to reasonably educated people outside our profession.
2. Apropos of “The ultimate problem here is not one of fraud and wrongdoing, but rather of bubbles — inflated asset prices and inflated expectations:” I’m not sure this is so “ultimate”. It might be that the ultimate problem is the US infatuation with debt to finance growth and everything else. Certainly some in Europe hold that view, and quite reasonably so I think. See, e.g., http://hebdo.nouvelobs.com/hebdo/parution/p2290/dossier/a384253-mort_à_crédit_.html .
The debt obsession is something that runs deep in our business culture, even to the point of MBAs being taught that they’re dumb, or betraying their shareholders, if their companies are “underleveraged.” The developments of the last week or two seem like a good opportunity for some soul-searching about such attitudes.
John Armstrong - September 26, 2008 at 1:34 pm
There is a tendency for people to moralize what they do not understand. Assigning causation to evil doers is a mental shortcut that may make some sort of cognitive sense in face of complexity.
Hanlon’s Razor: “Never attribute to malice that which can be adequately explained by stupidity.”
The decision makers here weren’t evil, just stupid. They made stupid assumptions that, in hindsight, are even more glaringly stupid. But that doesn’t mean that there isn’t a benefit to punishing their stupidity.
Miriam Cherry - September 28, 2008 at 12:02 am
“The securitized debt market is $13 trillion and the credit derivatives market is $64 trillion. A couple of hundred million dollars is chump change. Still it is important to realize that there are a lot of people out there who think like this, and they vote.”
I wouldn’t be so dismissive of those who adopt this argument.
I agree that it’s bubble related but why not chase down these hundreds of millions of dollars? Maybe “chump change” compared to the magnitude of this debt but worthwhile if it reduces costs for taxpayers even slightly.
There’s no conceivable reason (other than an odd notion of freedom of contract) that execs of failed companies should walk from this debacle in the money (I say odd notion because everything else related crisis has gone topsy turvey on contract, not to mention re-written the rules both ideological and political).
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