Archive for June 9th, 2009

Pay Czar Is Not the Answer

Tuesday, June 9th, 2009

“The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation,” according to The New York Times. Kenneth Feinberg, supervisor over the payouts to the families of the victims of the September 11, 2001, terrorist attacks, will enforce these compensation restrictions as the government’s new pay czar.

Smeal’s Tim Pollock, who studies executive compensation, is skeptical of the plan, stating the new position will create more problems than solutions.

More from Pollock:

Executive pay is out of control and it can’t be fixed by government regulation. Whenever the government tries to regulate compensation, compensation consultants always find a way around the regulations. In the early ‘90s, the Clinton administration tried to rein in executive compensation by limiting the tax deductibility of executive compensation in excess of $1 million, unless it was tied to company performance. This led to the increased use of stock options and instead of limiting executive pay, their pay skyrocketed over the ensuing 15 years and led to some of the risk-taking we see today.

Another problem arises with the current regulations only applying to companies that have received funds from the Troubled Asset Relief Program (TARP). If they are limited in what they can pay and their competitors are not, it will create an uneven playing field, making it even more difficult for these firms to recover.

It is also important to keep in mind that when talking about the financial services industry, the compensation of the traders and other mid-level employees is just as great an issue. They are the ones making the trades and engaging in excessive risk-taking that hasn’t gotten the financial services industry into trouble.

Nothing is going to change as long as 1) traders and mid-level employees are rewarded for taking risks that pay off and don’t suffer any consequences for the risks that don’t, 2) their compensation and the compensation of executives are tied to short-term performance measures, 3) analysts, directors, and others continue to focus excessively on short-term performance metrics (quarterly earnings) and over react to hitting or missing their expected earnings, and 4) most of the players involved have little or no understanding of how the financial instruments they have created work.

There has to be a massive culture shift on Wall Street that takes a longer term perspective on rewarding performance and making the traders and decision-makers responsible for failures as well as successes. The well-being of the system as a whole must be taken into account and not just the narrow self-interest of the traders, executives, and their firms.

Tags: Economic Crisis, Executive Compensation, Pollock
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