As I predicted whining has begun about reduced pay packages at financial firms bailed out by the U.S. taxpayer. Specifically, AIG’s CEO Robert Benmosche is threatening to step down at a critical juncture in AIG’s restructuring. Primarily he is upset by pay. And now the Wall Street Journal is featuring a video story entitled, “Why we need fat Wall Street Bonuses.”
Is that really true?
We do not need fat Wall Street bonuses. It is all about proper contracting. If an executive takes the reins of a large business and knows ahead of time what the pay package is “reduced” then that executive consents to that pay package by taking the job in the first place. What is required though is a massive re-think in how compensation is awarded. In particular I advocate regulation of these pay packages. Why?
For one, the size of the compensation packages is gigantic and out of all proportion with actual executive performance. For another, executive compensation has increased every year and in excess of inflation or overall U.S. worker wages and for decades. In other words, the pay scales are way out of whack. Without regulation a firm’s board of directors cannot scale back executive pay as long as a competing firm is ready to swoop in and award that manager more money. In other words, we are caught up in one of those “everybody else is doing it, so we do, too” vicious circles. So a powerful third party needs to step in to end the pay practices of Wall Street. That third party role is aptly filled by government. I fully acknowledge the difficulty of implementing such a system. However, as has been much discussed here on the blog since its inception, executive pay is one of the two primary reasons that the U.S. financial system bankrupted itself (the other being a poor regulatory environment). So this is a battle worth waging.
What the potential downside of fighting this fight?
In the short term executives like AIG’s Benmosche will refuse to play. There will be a panic amongst business-thinkers and they will say things like, “Without high pay we cannot attract top talent.” But then pay scales will adjust downward. Then talent will still be interested in these jobs because it will still be the best paying gig in the world. Lest you think that athletes make crazy money, just look at the rewards of highly paid Wall Street and corporate executives. Geesh! However, these consequences are entirely short-term, and long-term you have an executive compensation plan more in line with reality, and you shake the tree loose of people who are entirely, overwhelmingly motivated by money. Not a bad outcome in my opinion.
Jason
PS – One of the creepy things about AIG is that as I review my readership logs their servers check the blog every day. I am guessing that they have a gossip, blog and snoop patrol inside their business. Another way for AIG to stay out of the news and avoid bad publicity is to manage their business well. When that happens then no one has anything negative to say about them. Funny that. Capitalism works in many mysterious and wonderful ways.
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