February 5, 2009  ·  Lessig

So I’m the first to agree that the structure of compensation on Wall Street was begging for just this sort of disaster. But I don’t get the wisdom of the pay cap.

The pay cap means there will be two kinds of firms — one that can pay people whatever it wants; one that is capped (at different levels no doubt). But then the best employees from the capped firms can move to the uncapped firms, leaving the, well, not best employees overseeing the recovery of this now government invested firms.

Why do we want to be creating an incentive for not quite the best managers to be managing the recovery of firms we’re financing?

  • Brian

    I suppose it may provide an additional incentive to not beg for a government handout.

  • http://www.theonlinerant.com Jamie

    Ahh, the wonder of quasi-government private businesses. Look at how well run the US Post office is. Great things to look forward to.

  • http://3dna.us/ Jim Gilliam

    So the executives will stop looking to the taxpayers to bail them out.

  • Adrian Lopez

    Isn’t the cap like 500,000 dollars, yet the dirtbag executives are still complaining? Greedy bastards don’t deserve to benefit at all from public funds. The purpose of a bailout is purportedly to save the economy, not to ensure these idiots can buy yet another mansion.

    If the government wants to fund private business, perhaps it’s time to let mismanaged businesses go under, and focus instead on funding small and medium bussiness creation and expansion?

  • Jonathan

    maybe because the firms we’re financing are not the best firms with the best people (they got into this mess, remember? can’t be that bright), they’re just the firms that need to survive, hence the bailouts…

  • rick

    Well, people with uncapped compensation got us into this so i’m not sure I see a clear correlation between pay and competency here.

  • P.

    Politicians don’t understand system dynamics: that all aspects of a system interact with one another.

    Politicians think they can just change one little thing and, holding everything being equal, it’ll fix the problem.

    But everything else isn’t equal. People affected by the “one little thing” react to it — changing their behavior, often in ways that frustrate politicians.

  • AC

    By that line of reasoning, the firms that pay big bonuses should have had the best managers and thus been just fine and dandy.

  • http://laboratorium.net James Grimmelmann

    The “best” managers didn’t exactly do too well getting us into this mess. The events of the last few years inspire little confidence that Wall Street firms have much ability to distinguish between “best” and “not quite the best” managers, if that distinction even exists.

  • Kristian Z

    Are you kidding? Lots of talented people will be willing to accept prestigeous positions in Wall Street firms for $500k a year. No problem at all.

  • http://creativityinbusiness.net Steve Baker

    My initial reaction to this idea was the same as yours – the most talented managers will be lured away from the ‘bail-out sector’ by the multi-million dollar bonuses on offer from those companies that managed to avoid the need for state support.

    However, this is pre-supposing that the only reason anyone would want to run a company is for the salary. Does that apply to countries too? Would the US get better leaders if the salary for the highest office wasn’t capped at $400k plus benefits? There are many people who choose to do what they love and believe in regardless of the pay.

    Perhaps these faltering companies would benefit more by employing talented, ambitious leaders who want to do something other than simply line their own pockets as fast as possible. What about a mandatory term for the best (and the road for the rest), then, having proved their worth and ability they can move onto the lofty heights of unsubsidised private enterprise? Isn’t that how being a top public servant works?

    Or maybe ‘slumming it’ for four to eight years on a half million dollar salary is too high a sacrifice for these captains of commerce?

  • Miloch

    I don’t agree that there is the kind of fluidity you presume, I don’t see them skipping over so easily.

    It also isn’t always true that competency and greed are perfectly aligned. The more rapacious types are going to go for the money (pre and post era bailout) but their decisions and abilities are guided more by recklessness than prudent risk.

  • Benj

    If by the “best managers” you mean the people who have been able to command the highest salaries in the last decade, then the “best managers” are the ones who created the financial crisis. Most of these banks are actually insolvent. The next step is for the govt to separate out the banks that are technically insolvent (most of the big banks with high CEO salaries) and close them down. You can get a good insolvency lawyer CEO for each of these banks for less than 500K (a lot cheaper than a Goldman CEO from former years, obviously). The step after that is to split banks into two types 1) utilitarian banks with capital ratios that make it impossible for them to become insolvent in the future, but are guaranteed by the govt and 2) risk taking financial companies that explicitly the government will never bail out. The utilitarian type bank CEO could be bought for 1-2 million a year. The risk taking banks should have CEOs whose compensation is tied to long term profit, and that profit will be constrained by compulsory insurance not only of the bank’s individual risk, but also its systemic risk.

    For now, yes, executive compensation caps could be an excellent way to weed OUT the “best managers” you are referring to.

    The economist making the most sense right now is Nouriel Roubini. Read his RGE Monitor.

  • http://www.longlonelyroad.com RainbowW

    so give them unlimited restricted stock options that can’t be sold or transferred until after the bailout money is paid back, and unlimited bonus potential after the bailout is paid back. that is, you get a billion shares and $50 billion … after the government is paid off, payable immediately upon release of the government’s preferred stock.

    this means:

    a) they still have insane earning potential; and

    b) the taxpayers get their money back; and

    c) the taxpayers aren’t made to feel like their taxes are being used to pay seemingly outlandish salaries to people who don’t know how to book a train ticket; and

    d) the earning potential incentivises getting the taxpayers paid off, which is the behavior we want.

    i frankly don’t see the problem here, except that some execs will get their panties in a wad because they want it all now.

  • http://Www.fairwavemedia.com @fairwavemedia

    BTW, I’m enjoying “Remix.” However I disagree here. The problem is an abundance of greed and lack of integrity. The pay cap addresses that. The economy is such that any major moves are unlikely. And if relocation is eminent, good riddens, it’s time for the diamonds in the rough to emerge.

  • Eivind Kjørstad

    That supposes that there is an actual quantifyable difference between the skills of the best person you can get for $500K/year and the best person you can get for $17million/year, for example.

    I sincerely doubt that. The salaries at the peaks seem pretty random, and my guess would be it’d be pretty hard to show any statistical correlation whatsoever between pay and performance at these levels.

  • Wes

    The pay cap means there will be two kinds of firms — one that can pay people whatever it wants; one that is capped…

    So cap them all.

    More specifically, tax all income above $500,000 at 90% and tax all income about $1,000,000 at 99%. Either somebody eventually pays for this “stimulus” or the USA ends up like those developing countries that print up so much money that it takes a wheelbarrow of money just to buy a loaf of bread – and about the only people who can even afford to pay taxes at all are the rich people.

    Sure, the bank CEO may not have a hundred grand to blow on plastic surgery for his third mistress but, on the plus side, the government will have that hundred grand to provide needy children with basic medical care. The plastic surgeons lose a little business and the primary care physicians gain a little business.

  • http://blauebirke.wordpress.com/ bluebirch

    High managers salaries are determined a bit different than lower workers salaries. A inner circle at the top of the company decides on the salaries of each other. At least here in Germany the average salary for the past few years went down. However the salary of the managers when up by ~30% each year (pre pay caps).

    Pay caps in this sense are just a “dirty hack”. And will lead in the end to a pre crisis situation. Which seems to be the way this crisis is headed.

  • Jonas

    I’d like to read this post but I can’t SINCE THERE’S A POPUP CALLED “POPULAR SEARCHES” BLOCKING THE POST TEXT WHEN USING INTERNET EXPLORER. Please fix that.

  • Tim

    I don’t think anybody is worth that kind of money (uncapped). If anything, the caps will mean that you’ll still get quality people in capped firms – who are more likely than not, able to care.

    You’ve gotta ask yourself Lawrence… how can one person be worth so much money? So much, that they surpass entire communities, and entire countries? The balance has to be redressed. If you can think “commons”; then you can think globally, and get some kind of sense of human equity.

  • http://blog.thecapacity.org jay

    It’s a valid concern but I don’t always believe that “better paid” == “better skilled”.

    Some of the best will stay for the challenge, and some of the best will stay because they feel like they should.
    I’m sure there are other reasons why the skills and talent won’t bifurcate as people expect.
    Take layoffs for example, I’ve often known companies to lay off talent they know can find a new position and keep people I’ve known to be incompetent (but better paid) except for their ability to convince management they know something.

  • Rick

    A surprising comment, Lessig, from someone who should be aware of the vast amount of ability and creativity on this planet. You’re thinking inside the box.

    1. The securities and exchange business was never intended to be one requiring great creativity or management prowess. Indeed, quite the opposite. It’s supposed to be tightly controlled to ensure stability and security.
    2. The “geniuses” of Wall Street did not attain stature (and wealth) by working within those guidelines. It was by the creation of unsound financial instruments and practices while working the political landscape to create loopholes or simply avoid scrutiny. Is that what you want to continue?
    3. Competition, which was thought (or at least heralded) as the self-regulating force has not worked. For several decades the modus operandi has been to get in, make a fortune any way possible, squirrel it away in a numbered account, and get out. Why “compete” with that when there’s tons of easy money to go around?
    4. Existing Wall Street management has demonstrated repeatedly an arrogance, even disdain, for the notion that they have any responsibility to the government, and hence the people of this country; a curious posture given that their business exists purely as a legal entity created by this society. The mindset is decades old and needs to be broken.
    5. The human suffering resulting from this financial collapse will far exceed that of 9/11 yet we treat these “economic terrorists” as if they just had a bad day at the slot machines; we’ll bail them out and let them go on their merry way. They laugh at our stupidity.

    I could go on (ad nauseum probably) but the bottom line is this: You understand the political arena so “Change Congress” makes sense to you. This is no different and involves all the same issues. Fact is, addressing these issues will likely have a significant impact on the “pay for influence” game. How is it that we can advocate the election of Presidents with relatively little experience yet be scared shitless to allow new blood to manage our financial institutions?
    Anyway, do you REALLY think the salary cap is anything more than appeasement to the American people? The current hoopla will fade and the Wall Street boys will figure out how to work the system to get their booty. They’re masters of that, remember?

  • Jardinero1

    In the insurance business, we use the term, adverse selection, to describe the problem Prof. Lessig refers to.

    To Rick,

    Competition does not assure pleasant outcomes. It does assure economically efficient outcomes. Competition as a disciplining force works very well, if you let it. By discipline, I mean driving the foolish, stupid and weak out of the market forever, .ie. they fail. This is what should happen to the institutions who are being bailed out.

    The financial industry is not a bridge, or a dam or a tall building. If it falls, there won’t be death and destruction. There is not going to be a pile of rubble. There will not be years of debris removal followed by years of reconstruction. No, the financial industry is a bunch of accountants and mba’s who meet in rooms with other accountants and mba’s and they shuffle paper around. It is a meeting of minds and a bunch of paper contracts. It is an easy thing to start anew. The worse thing one can do is continue to provide aid and shelter to the individuals who brought on the crisis in the first place. Let the sick companies go bankrupt. It’ll be alright. The bank deposits are insured and state guaranty funds protect the annuities.

    There are numerous, literally thousands, of well managed small and medium sized banks in this nation who are prepared to take on the distressed assets that BofA and WaMu and Wachovia, et al have in their portfolios.

    There is no need for a bailout. Let the FDIC, the state guaranty funds and the bankruptcy courts do their jobs.

  • Fanni K

    I agree with Larry and this seems like a reasonable idea, coming from a top executive whose services we all like: http://www.nytimes.com/2009/02/06/opinion/06hastings.html?emc=eta1.

  • http://www.coldorbit.org Etherspirit

    SALARY CAPS ARE INCONSEQUENTIAL.

    This is a PR stunt to make Americans feel better. An obviously easy one for Obama to jump on.

    $800 billion vs a few hundred million? Everyone is talking about CEO salary caps, and nobody is actually talking about what will actually make a difference (hint: $800 billion).

    *

  • Patriot Henry

    “This is a PR stunt to make Americans feel better. An obviously easy one for Obama to jump on.”

    Bingo!

    Note that the salary cap only applies to salaries. It does not apply to bonuses, stock options, deferred payment plans, golden parachutes, or payments in commodities such as gold or silver or diamonds, or fine art, etc etc etc.

  • Rick

    @Fanni
    Corporations and the very rich always trot out the old tax-rate argument when they sense rumbling from the peons. The fact is that by the time the bean-counters get finished the actual taxes paid is a small fraction of the rate. Don’t forget the immortal words of Leona Helmsley: “We don’t pay taxes. Only the little people pay taxes.”

    Increasing the tax rate is simply accommodated by increasing their compensation, so the well-paid would prefer that the rate increase if something HAS to happen. These are capitalists. Give them a pile of money, some good accountants, and a favorable tax system and they don’t care WHAT the tax rate is. Take away a capitalist’s pile of money and he’s dead in the water.
    More importantly, a rate increase would impact all execs in that bracket, most of whom are doing just fine in terms of performance and even moral and ethical responsibility; they’re trying to remain as invisible as possible and avoid having a public position on the ugly side this mess. The Netflix exec’s strategy in calling for a rate-increase is to drag everyone in the bracket into the fray and turn this into a class-war. That’s the last thing Obama needs.
    The underbelly of this whole thing is that not only is there disgust with the Wall Street perpetrators and our government, there’s the growing sense that our legal system simply does not penalize guys like these. Indeed, the law in fact protects them from loss, at least in any criminal sense. As long as they play close enough to the rules the worst that can happen is they get fined. There’s no incentive to NOT play the system as long as the take-out maintains sufficient margin over the potential liability. Embarrassement? Shame? Not hardly. Well, okay, maybe a sheepish grin while being heckled by their friends at the club for having violated the Eleventh Commandment: “Thou Shall Not Get Caught.”
    Make no mistake here. This isn’t “Golly, that’s too bad Beaver!” kind of stuff. This wasn’t “Gee, what are those regulators doing?” This was a cold, premeditated milking of this countiy’s wealth, OUR wealth, with full complicity by the Bush administration, including an exit strategy that, in the end, presented Congress with a scenario that in any other venue would be labeled simply “extortion”.
    For execs in the hot seat I’d suggest they take their lumps and go quietly. They’ve screwed around with a great many people’s hard earned money. There was a time in this country when “frontier justice” would have dispatched them swiftly and far more severely.

  • Dan

    Just a short question: Why would any (relatively) healthy financial institution want to hire someone who significantly helped their old institution fail? Are these execs that are expected to jump ship for better salaries actually going to get those salaries? Isn’t there a glut of labor in the financial executive market these days?

    Seems to me the labor market here is probably more complex on the ground than a simple bird’s-eye view would have it. I fear for the healthy institution that hires-away such “talent” from institutions that failed.

    Why aren’t these guys tainted by the failure? Is it all “there but for the grace of god go I” — and then were the “healthy” institutions just dumb-lucky in the end?

    Maybe this is the perfect time for a changing of the guard. Maybe getting rid of overpaid people who think they deserve their overpayment is a *good* thing for these struggling institutions. Maybe the bubble in financial executive pay should burst along with the other bubbles that have exploded recently. It’s hard to believe that such compensation was ever really rational in the first place.

    The classical market is premised on the assumption of rational action (at least some reasonable approximation to it, as we know the absolute is humanly impossible). Executive pay seems as if it has been immune to that criterion. Maybe that could change. Maybe that would be a good thing.

  • http://example.com Anonymous

    The idea that there is such a limited number of people capable of running these companies that you need to pay them millions each year is absurd. Additionally, in my experience (my company provides services to banks), the people leading these companies did not get into these positions because they were the most qualified. Rather, they got there because they were the most ruthless, egoistical and – sometimes – sociopathic. In other words, the people who will only work for you if you pay them these insane amounts of money, the people who are attracted to these kinds of insanely well-paying positions, these are precisely the people you can’t trust with running your company.

    If these pay caps help corporations get rid of the people who only work there because they receive millions each year, then the pay caps are the best thing that ever happened to these corporations.

    The mere reason that somebody makes a lot of money does not mean that he (and it’s almost always a he) actually deserves it. I realize that this is a bit of an un-American thing to say, but I’m not American, so there :-)

  • http://www.limitedliabilitycompanycenter.com/ David

    If the salary cap were very low, it would be a problem. My bet. however, is that there are plenty of excellent people who would be thrilled to have these prestigious well-paying jobs even without the obscenely high salaries and bonuses.

  • Benj

    Yves Smith has a great post on this at http://www.nakedcapitalism.com/2009/02/obama-to-neuter-bank-pay-restrictions.html

    a snip from her post:

    1. People in these firms (the large banks on life support) were overpaid by a considerable degree in the last few years. The earnings were bogus (they were hugely overlevered relative to the risks they were taking; in addition to holding more equity , they should also have made greater loss provisions). So recent pay is no guide for what their services are worth

    2. The companies ought to be in turnaround mode. Normally, the board brings in a new CEO. the CEO sets a new direction and replaces people at the top either lacking in the right skills or unwilling to support the new program.

    3. The managers and line staff were hired when these companies were drunk on growth and fat fees. They are by temperament and training the wrong type now. Look how badly the once well-regarded John Thain stumbled at Merrill

  • http://www.recallwalker.info Dave from Milwaukee

    what about moral hazard

    do to the banks the way the Govt did to the Postoffice and sell each new employee a Kalashnikov. It will help our relations with Putin and the Russians will not follow through on their plans to invade

  • Jon

    >>I suppose it may provide an additional incentive to not beg for a government handout.

    Exactly. Moral Hazard. We only want companies to get a bailout if they really truly need it, and it has to be a bit of a bitter pill. Otherwise all the other companies who didn’t need a bailout because they didn’t engage in such risky behavior will be the ones being punished.

  • http://fetter.org David Fetter

    Two words: Maximum wage. We’ve decided that there needs to be a floor to compensation. Why not a ceiling?