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Slippery Slope of the Bailout   February 4th, 2009
Government shouldn't limit CEO pay, but has to when government bailouts are involved       


More observations...

The government bailout of banks, TARP, has moved us on to a slippery slope where normal conservative principles can't always apply. Government involvement in the private sector via the bailout has caused an ideological paradox when it comes to the issue of CEO pay.


Obama, along with Treasury Secretary Timothy Geithner, is set to cap pay for government-aided Wall Street executives at $500,000, according to a senior administration official, at the White House Wednesday...

Compensation experts in the private sector have warned that such an intrusion into the internal decisions of financial institutions could discourage participation in the rescue program and slow down the financial sector's recovery. They also argue that it could set a precedent for government regulation that undermined performance-based pay.

Some Republicans, angered by company decisions to pay bonuses and buy airplanes, have few qualms about restrictions, especially if they are temporary.

"In ordinary situations where the taxpayers money is not involved, we shouldn't set executive pay," said Sen. Richard Shelby of Alabama, the top Republican in the Senate Banking Committee.

"But where you've got federal money involved, taxpayers' money involved, TARP money involved, and the way they have spent it, with no accountability, is getting close to being criminal."

Indeed, Senator Shelby is right. The government should have no place in determining or limiting CEO compensation under normal circumstances. But when it comes to massively expensive bailouts by the taxpayer, it seems completely inappropriate that the companies should be able to use that money to pay excessively high CEO salaries.

Having said that, limiting CEO pay will limit the pool of experienced and capable CEO's that would be willing to take on the job of fixing a failing organization. While it's clear that many CEO's were paid a lot of money to do a bad job, that doesn't mean good CEO talent capable of fixing a sinking ship is going to be willing to do the job for $500,000/year.

In everyday terms, suppose you had a problem with your sink and paid a plumber $500 to fix it. Instead of fixing it, he broke some seals and flooded your kitchen. You rightly fire him and look for another plumber. But as you interview potential plumbers to fix your kitchen sink, you tell all the qualified plumbers, "Since I paid too much money to the last plumber and he made the problem worse, I'm only going to pay you $100." So many of the qualified plumbers that might be willing to do the work for $250 simply choose not to accept the job. Sure, you might get a qualified plumber to do the job for $100; or you might find that only an unqualified plumber is willing to do the work for that amount. And he might solve the problem. But limiting the salary limits your possibility of selecting the best person for the job.

This is the paradox of government involvement in the private sector and what happens when we mix public funds with private institutions. The use of government funds demands that we place limits on what could (arbitrarily) be considered excessive salaries. On the other hand, limiting salaries will limit the number of potential CEO's that are willing to take what will obviously be a very challenging job that will be subject to a lot of stress and scrutiny.

This apparent conflict of fiscal conservatism (wanting to allow the free market to determine salaries but recognizing that responsible government oversight demands limits on those salaries) only exists because the government got involved in something it shouldn't have: the private sector.

Update 2/4/09: After writing the above comment, Fortune magazine concluded about the same thing.

Politicians like to be popular. By that standard, Barack Obama's reported plan to put a $500,000 cap on salaries for top executives at companies that depend on government support is a great idea. But from almost any other perspective, the new U.S. president is courting disaster.

True, a philosopher-king in charge of executive compensation might establish a similar limit. Management theorists used to say the big boss should be paid about 20 times the salary of an average worker. That would suggest a cap of around $700,000 in the U.S.

In the real world, though, this sort of constraint is likely to make bad companies worse. A few public-spirited executives might relish the opportunity to run troubled enterprises for much less pay than they could garner from overseeing more successful ones. But amid an unprecedented financial crisis, the government cannot really afford to be stingy.

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