The news of the day is the decision by the Obama administration to put caps on executive pay, at least at the companies that have lined up to received funds from the government. Not surprisingly, there are people with strong views lining up on both sides of the issue. So, I guess I will stick my toe into the water and hope not to get burned (since there is an obvious political component to this debate).
As a general rule, I don't think governments should have any role to play in setting compensation limits. The heavy hand of government intervention will not only create quirks in the labor market but have unintended consequences. For instance, the US government (in its last populist phase in the early 1990s) decided that executives were getting too much and decided to restrict the compensation that firms could deduct for tax purposes to $ 1 million (per executive)... Since compensation was defined in the legislation as pay and bonuses, and did not include options, it played a role in triggering the huge option packages that executives have received in the last two decades.
But here is why I am torn. The proposed executive pay cap is toothless for most companies and will have an impact only at those firms that have used the federal government as a piggy bank (Citi and BofA ). If we accept the proposition that there is no free lunch, these firms asked taxpayers for capital, were provided this capital and are in no position to deny taxpayers a say in how they make decisions or compensate employees. (As taxpayers, we are singularly unfortunate that we are represented in this process by legislators who have the attention spans of infants and the time horizons of riverboat gamblers...) Faustian bargains have a way of coming back to haunt you.... You lie down with dogs, you wake up with fleas!! (No more analogies, I promise!!!!)
I must close by noting that I think executive compensation is way out of hand at many companies but I think that just as voters in a democracy get the government that they deserve, stockholders are getting the treatment that they too deserve. If we want compensation to be reasonable, and by reasonable, I am not ruling out very large compensation for managers who truly deserve it (Steve Jobs at Apple should be given a few hundred million), we should not be looking to the government for solutions but to ourselves. Investors, and especially institutional investors, need to work to put in place rules that give them more say in compensation. I also like the British notion of putting top management compensation agreements up for stockholder approval routinely.
8 comments:
Shareholders should undoubtedly have more say over executive compensation. The vast majority of shareholders fall under the category of an "investor". An investor(owner) in the company cares about the value of the company. This value is determined by the long term outlook. To supposedly align executive(agent) incentives with shareholders(principal) incentives, stock options became the hugely popular answer. The problem with stock options is the incentive for short term performance(real or fraudulent) at the expense of long term performance.
Stock options, as they are structured currently, align incentives at the correct target(shareholder value), but totally miss the boat in aligning the time frame of the goals.
The problem is amplified because short term incentives for the agent is so large. A multimillion dollar bonus for a single year is enough wealth to live very comfortably for life. On top of this, due to the almost absent activist shareholder, no principal has enough skin in the game to really care if a company he owns goes under. Hell, thats whats expected to happen and thanks to the magic of diversity he doesn't have to care.
My solution are vague as I'm not smart enough to fill in the details:
1. Align agent and principal incentives both in the short term and the long term.
a.clawbacks?
b.more criminal enforcement?
2.Make the principal actually care about whats going on with the company in which they are invested. (This is really the tough one.)
I agree that as a general matter the government should stay out of the compensation arena, and I very clearly remember the mess created when Washington tried to use the Internal Revenue Code to limit executive remuneration. But now we have a situation where the government is investing sizeable sums in troubled companies. Just like any other private equity investor I get a "seat on the board" and a right to make sure that management is not sucking out cash before I get my investment out. So I think that under these circumstances it is "philosophically" okay to allow the government to limit compensation. The unfortunate facts of the real world, of course, are that the politicians doing this are by and large at best a bunch of inept, inexperienced, ill-advised incompetents who couldn't make it in private industry if their lives depended upon it...and unfortunately ours do.
I don't think the compensation cap is restricted to $500K total. According to several news articles: "Firms that want to pay executives above the $500,000 threshold would have to use stock that could not be sold or liquidated until they pay back the government funds." So it appears he is only limiting cash comp and stock-based comp is aligned with taxpayer/investor interests too.
Also the restriction on selling such stock till such time the taxpayers are paid back, means that hopefully these execs can't game the numbers for short-term stock price appreciation. All that being said, I am sure compensation consultants and lawyers will find some way to manipulate the new rules.
Also in his presidential campaign, Obama promised the very thing you are proposing i.e. shareholders have a vote on executive comp. He called it "Say on Pay" (http://www.cfo.com/article.cfm/11037327/c_11036422). Let us see how he implements these ideas.
Another solution that should be given more thought is to minimize certain legal restrictions that make it infeasible for institutional investors to come in to take over companies with excessive executive pay. Making it easier for hedge funds and private equity to come in to take over poorly managed firms would not only have the direct benefit of punishing bad managers of taken-over firms, but also act as a deterrent to future power-hungry executives. Just a thought.
I think the problem with executive bonuses in the troubled quasi-government firms just reminds of the bail-out problems - the government shouldn't have provided help to companies, which are practically insolvent in the first place.
In addition, executive compensation caps will further increase the principal-agent problem by reducing incentives.
Great thoughts!
Gauging excessive executive compensation is something we have written about a while back as well: http://www.onefamilysblog.com/2008/07/exec-proofing-part-1-avoiding-companys.html
Regards,
Maybe executives should be paid according to hedge fund style compensation of high water mark barrier in order for them to receive more bonuses. After all, they are the asset manager seeking to maximize returns for shareholders.
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