Unreasonable executive pay is a symptom, not a cause, of our broken system.

Mark Thoma raised the question here whether outlandish executive pay should be capped or perhaps subject to higher tax rates on the outlandish part. As I read the post, the comments, and a NYT op ed piece by Lewis and Einhorn (linked below), the executive pay question came into better focus for me.

My first reaction was that I was being asked to choose between solutions when the problem hadn't been defined yet. I posted this:

What exactly is the problem that requires any government intervention? Is it that top executives are taking advantage of shareholders? Is it that what should be a marketplace for executive talent has been captured and is not working properly, leading to misallocation of resources and economic "inefficiency"? Is it envy? Something else perhaps? Maybe not really a problem at all?

One or two commenters suggested it was a cosmetic problem deserving of attention and that there are income distribution effects. I was underwhelmed and posted this.

I agree corporate governance in big US companies is not the best way to do it. But all of the points raised above, and others, have been the focus of attention since at least the 1970s, and some efforts have been made to improve the system. IRC Sec. 162(m) limits the deductibility of executive pay in excess of $1 million unless "performance based." Improved disclosure of executive compensation. Shareholders have slightly improved ability to get votes on dissident proposals. (To the contrary and unfortunately, the rule that forfeited to the company "insider trading" gains from exercising employee stock options and selling within 6 months of each other was abrogated some time in the 1980s.)

I've not done a study, but my impression is that the worst executive pay abuses (I agree they are abuses) are in finance and industries in which financial transactions (such as roll-ups, refinancings, and generally "creating shareholder value" by balance sheet transactions rather than through operations) dominate the business plan. I attribute that (again without study) to the different traditions of compensation that grew up in investment banking from those in manufacturing and retail. The former, a deal-making tradition, was fee driven--taking a percentage of the value changing hands. The latter was driven by operations targets, like earnings, in businesses that took a longer view of things and prized "management skills."

Still, I see the struggle as being primarily between the shareholder class and the executive class without substantial implications for middle class incomes. And, again without research, my impression is that although CEO compensation can be far larger than is warranted, it's not in normal times many cents per share, which is I assume why shareholders grumble but still hold shares.

If y'all can make a persuasive link between changes in corporate governance and/or executive compensation, on the one hand, and getting the middle class moving again, on the other hand, I'll join the mob and bring my own torch and pitchfork. A shareholder rights movement would not have the same visceral appeal to me.

Then I read the morning fish wrap and realized that outlandish executive compensation is a symptom, not a cause, of an out-of-control financial industry and posted this:

The governance failures of government dwarf the governance failures within companies. Contrast this discussion about executive pay with The End of the Financial World As We Know It by Lewis and Einhorn in today's NYT Opinion.

Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O'Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup's chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower — had stood up and said "this business is irresponsible and we are not going to participate in it" — he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he'd be replaced by someone willing to make money from the credit bubble.

The online version is preceded by focusing on definition of the problem to be solved: "We have a brief chance to cure ourselves. But first we need to ask: of what." I see outlandish executive pay as a symptom, not a root cause. Dean Baker is on the right track here. Echoing Grover Norquist, he just wants to shrink it [the financial industry] down to an appropriate size.

Update on Sunday, January 18, 2009 at 11:26AM by Skeptic

I've moved the penultimate hyperlink to The End of the Financial World as We Know It from the misleading place I initially put it.  The "contrast" in the discussion is not between two NYT pieces but between the NYT piece and the discussion in Thoma's blog. 

The quotation in the last paragraph I said introduced the online version of the NYT piece isn't there anymore, but it is and was at the end of the third paragraph of the piece.

Update on Tuesday, April 28, 2009 at 09:34AM by Skeptic

This post says "obscene Wall Street salaries are proof of market failure."