Cap executive pay

A powerful social science theory, much advanced by Robert Frank of Cornell, provides a strong rationale for setting a ceiling on the incomes of the executives of all corporations that receive public loans, capital injections, or some other favor from tax payers. (Surprisingly many, by the way, if you include specially tailored tax loopholes, credit below the market rates, export assistance, and so on). Before I can lay out what the theory of relative deprivation suggests the next Congress and White House should do in this department, a few words on how we got executives who are paid scores of millions in the first place.

You may well say that the astronomical pay checks -- supplemented by bonuses, stock options, and all kinds of other goodies from executive jets to suites in five star hotels -- simply reflect unfettered greed and the fact that, at least until recently, most corporate boards approved whatever pay schedules their executives put in front of them. (These boards included many of the executives’ friends and retirees keen to collect hefty fees for attending an occasional meeting and voting yes.)

All this is true, but do not underestimate the role of Michael Jensen and his colleagues at the Harvard Business School. Professor Jensen was all the rage when I was teaching at what is called “The B School,” on the Boston side of Harvard. He was known for his die-hard support of the free market, and his arguments that executives were underpaid.  He held that given that executives generate billions in wealth for the shareholders of their corporations, to reward executives for their efforts, their income should rise as the market value of the company rises. Even if they just got a few percentages of the new wealth, Jensen argued, their compensation should have been much higher than it was at the time. No wonder he was the darling of the CEOs who visited the Harvard Business School with great frequency. They paid no mind, and still don’t, to Jensen’s argument that they should  also pay “big penalties for poor performance.”

Also, missing in Jensen’s and his associates’ proposal is any explanation of what, say, an additional million bucks would buy from an executive who is already making twenty. Because I was a member of a delegation that included CEOs, I got to spend several days with the CEOs of Protector and Gamble and of Boeing, and I met some others. I found them extremely hard working people. They worked long days, often taking work home, and traveled constantly from one plant to another, from one meeting to another, with little rest in-between. I cannot imagine that anything could make them work even harder –or, for that matter, that their business would benefit if they took even fewer times out. Nor can I figure out what one would buy—with, say, that last million dollars. An eighth house? Another sports car you have no time to drive?

The answer takes us to Frank and the theory of relative deprivation. Most CEOs use their compensation figures mainly as a measurement of prestige, a statement of their standing compared to other CEOs. They are keen to make more than the next guy or doll. (Indeed, this is the reason European executives, who on average make much less than Americans ones, are just as content as American ones, because their reference group are other European executives.)

A cap on executive compensation would not only save millions for the financially strapped corporations-- and be fair to the tax payers who help these corporations stay afloat-- but would also provide the executives with a new reference point. Anyone who makes the max allowed will have made it. No more need to try to outdo the other, money-wise. Such a ceiling would leave the CEOs free to do what is best for their corporations, the economy, and families-- rather than focus on ways to jack up the price of their stock each quarter.

Micro-blogging: Bother, can you spare a dime?
The executives of Goldman-Sachs just announced that they will forgo their bonuses this year and will do with a “mere” $600,000 salary. Given their performances this year, one wonders why they were entitled to bonuses in the first place. Anyhow, if you are worried about how they will able to do on this meager income, perhaps you could send them a Christmas food basket...

Comments

[jc]

You seem to be impressed with people working hard at being greedy - of course who wouldn't work hard when the sky's the limit - the Fulds and AIG CEOs need to be in stocks by Xmas Day at Rockefeller Plaza - and left there through the winter !!

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