Topic: Economic Policy
Obama's Cap on Executive Pay The Economic implications of capping executive pay for firms that accept bailout funds.by Jeff Peters
(conservative)
Thursday, February 5, 2009
According to this article, the president elect capped executive pay to $500,000 for all companies that will accept bailout money. I will outline the economic implications for this price cap.
The market will decide how to value the productive capacity of individuals. The expected or observed productivity of a worker, and the relative scarcity of the subject's skill set, will determine his or her worth to a firm.
To say that the market decides on the best allocation of workers is to imply that the pricing mechanism always clears the market. That also implies that artificial alterations in the pricing mechanism will cause supply and demand of labor productivity to readjust to new levels if a price ceiling is below the market equilibrium.
This is exactly the problem with placing a cap on pay. It will only cap the level of productivity exhibited by the executives - and perhaps cause a reallocation of this high productivity skill set to other industries.
One must remember that compensation prices serve as signals of productivity, which also means that lower prices will indicate a need for lower productivity. This will affect the overall productive capacity of a firm - which determines its cost efficiency and thus its profit.
All of these negative effects of caps on executive pay conclude with an increase in the risk of failure for a firm, especially in a time of economic instability. The best way to turn around a failing firm is appoint smart, and therefore pricy, executives; not less experienced individuals with less human capital.
This idea applies even more to firms that need bailout money, although executives with good pay may have less of an incentive to accept money with strings attached.
All in all, better executives will be needed to keep firms alive, but that may require more money than caps on executive pay allow. Regardless of the importance of high productivity, it would be interesting to discover if firms are in this mess primarily because of low productivity executives. However, I would still be skeptical if the government can price their worth.
There is one interesting idea on the other side of the boat. If fewer companies accept this bailout money, because of this radical cap on executive pay, then that may induce firms to act more responsibly given the few non-governmental resources available to them.
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Posted By: Walt Thiessen
Date: 2009-02-05 05:44:34
Good points. Of course, the real question is: why aren't the stockholders punishing the executives who made the bad decisions that put these companies into the toilet in the first place?
Because most stock holders have no choice but to either buy or sell. If you buy into a crappy company, you took the risk of losing, so the only way to "punish" is to NOT buy. But if you NOT buy, you are NOT a stockholder. Stockholder cannot punish the execsby just selling because most of them will be taking a loss also thus punishing themselves in the process for making the bad decision. Another thing you can do as a stock holder is do a proxy vote to limit compensation, but chances are you are a minority stakeholder and will have very little power. Another thing you can do is file a suit as a stockholder against the company, but then you are part of the company so is that suid yourself as well, and you will require lots of cash.
Other than that please tell me how the stockholders can punish the execs.
Posted By: Jahfre Fire Eater
Date: 2009-02-05 14:42:41
The dole = control.
The exec salary cap will help drive the financial center of the world towards the Middle East and Asia. Mr. Bloomberg thought the groundhogs were restless before, just wait until the financial district is abandoned.
Hi Christopher, your statements are excellent, well thought out with sound reasoning. Problem is, there is no "market" governing executive pay in mega corporations. Obama is basically applying an articial price ceiling [which is somewhat justified considering the investment] to a pay scale that hasn't been based on free market principles for decades. If market principles applied, they would all be out on their ears sleeping under some bridge!
And where are these executives who have been incredibly sucessful at destroying the balance sheets of conglomorates [who for the most part operate in a virtual monopoly] going to go because they resent their new pay ceiling? Would a prosporous well run organization hire someone who just recently brought a good company to its knees begging the government for a handout? Although, perhaps this is exactly what everyone is looking for!
Posted By: Jahfre Fire Eater
Date: 2009-02-07 08:01:49
Gene, I disagree. There is a market governing executive pay in mega corporations. The problem seems to be that you think it should be the same market that non-mega-corporations participate in.
If they do not feel compeled to participate in that broader, freer market, you think it is a proper appliction of government force to eliminate their current market by decree.
Of course, the consequences of prohibition are always black markets. If you do not believe this then I'd say we've reached the line that separates our incompatible frames of reference. In my frame, said consequences are a given. So, it appears that you support the creation of a black market for power positions exactly where the melding of government and industry exists in its most dangerous form.
Hi Jahre, No, I do agree with you that there is a "market", limited as it is for corporate executive compensation.
What I believe though, is basically virtually every action taken on a daily basis by the megaconglomorates is an action against the true free market, so in my thinking Obama's cap is arbitrary.
Better would have been to let the mega's fall, remove all government subsidies, bailouts should be illegal, etc.
I guess my frame is that a market with segments of freedom combined with large elements of forced or "advantaged" trading can not be considered a "free" market. I would be analagous to a person who is allowed to walk around freely, constrained with ankle chains anchored to a slab of concrete with a certain length of chain.
So I agree like you that there is a "market" for executive pay, but i percieve it as executives "competing" for positions of which a large part of the pay results from "unearned" revenues created by monopolization, etc.
I don't truly believe the state should confiscate this "unearned" pay, I believe they should stop "enabling" it. Sorry, for the misunderstanding!
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