Executive Compensation, Government Regulation, Oh My!

Why should the top officers of a company receive multimillion-dollar-pay packages? In many cases these top executives receive total compensation packages that are hundreds of times those of middle managers. How many of these executives make major contributions to their firms? How many Steve Jobs are there? More importantly, is it a sound management practice to establish such a skewed, two-tier compensation system? These organizations would be better served by spreading the wealth around to other deserving employees. Furthermore, providing millions of dollars in remuneration in any one year for employees can be counterproductive. These employees have automatically become independently wealthy. Companies that structure compensation packages that reward good performance over many years are providing a better incentive to maintain talented employees for longer periods of time. In addition, substantial compensation for short-term performance may create ephemeral rewards.

A classic example of how to structure remuneration properly was Goldman Sachs. It was one of the most successful partnerships. Partners had to keep the bulk of their money invested in the partnership. This led them to invest wisely for the long haul and avoid risky, alluring short-term bets. On the other hand, a case study in what not to do is Citigroup. This was an institution that attracted many talented, dedicated people due to progressive working conditions and compensation policies that were a cut above many of the other banking institutions. It was a tremendous institution until Sandy Weill literally single handedly destroyed its successful framework and corporate culture. He created a star system of so-called rainmakers that required the destruction of the compliance department and a level of compensation that the bank could not sustain without taking on more and more risk. Wall Street has created so many of these rainmakers that our financial institutions almost drowned.

Excessive pay for management and the board of directors has been building for years. Now it has reached a ridiculous level that is having a very corrupt influence on many companies. Time and time again, we have witnessed situations where the board has not performed its fiduciary duty to stockholders. Executives are receiving huge bonuses despite dismal performance, which is reflected in poor earnings and crushed stock prices.

AIG is now the poster child for poor management and the risk of improper government involvement. This company that was rescued by taxpayer dollars recently handed out 165 million dollars in bonuses. This, understandably, has created public outrage. However, in response to the public’s furor, The House of Representatives has hastily produced a confiscatory tax bill. The bill proposes to tax bonuses at a 90% rate for those individuals who make more that $250,000 at any institution who received more than five billion dollars in TARP money. This is the danger of having government involved in the day-to-day running of these financial concerns. Hopefully, this measure will not become law since it is counter productive. The whole purpose of the TARP was to stabilize the financial system by providing needed liquidity. Many of these institutions will try to get out from under punitive government control and pay back TARP money too quickly. This could undermine the purpose of providing for this liquidity in the first place. More importantly, such ex-post-facto, punitive laws are what our founding fathers warned against called “Bills of Attainder”, which undermine good principles of social compact.

As I pointed out in my commentary, “The Way the World Works”, government should act as a referee between the public and private sectors. Good government policy will permit the capitalistic system to function properly. If a company is mismanaged, we have to let it fail. This is called “creative destruction”, a term that was coined by the famous 20th century economist Joseph Schumpeter. This rejuvenates our capitalistic system by making sure capital is being used efficiently. The government’s role is not to rescue failed companies. That rewards and perpetuates failure, which is a misuse of capital. Its role should be to make sure that companies do not become so large that failure is no longer a viable option since it would put our entire financial system at risk.