News from the Pay Czar

Unless the Obama administration's plan is to subtly shrink or close down the seven firms receiving the largest TARP bailouts to the tune of hundreds of billions of dollars, the announced plan to cut executive compensation earns a nine on a scale of one to ten for stupid.  The best executive talent will find employment elsewhere, leaving the companies with insufficient expertise to guide them back to profitability.  At best, the move will lengthen the time needed to repay taxpayers.  At worst, it will increase taxpayer losses. 

Sadly, ABC News reported that 71% of respondents to a survey supported the policy.  Is revenge the motive?  If it is, taxpayers would have been better served by forcing the firms through bankruptcy.  Those interested in punishing executives that made bad decisions probably miss the mark as well.  They cleared out before the dust settled.  As a taxpayer, I don't want to get even; I want taxpayer money repaid. 

I believe that the administration's motives are pure.  They want to do what is best for the country, and in today's environment, that means speeding the recovery but the administration consistently seems to miss the strength of the profit motive to spontaneously order economic activity.  Instead, they rely on central organization.  Any single person like pay czar Kenneth Feinberg lacks the information needed to set salaries across industries and positions. 

Deborah Solomon of the Wall Street Journal reports on known details in, "Pay Czar to Slash Compensation at Seven Firms."

The U.S. pay czar will slash compensation for the 25 highest-paid employees at seven firms receiving large sums of government aid and demand a host of corporate-governance changes at those firms, according to people familiar with the matter.

Kenneth Feinberg, the Treasury Department's special master for compensation, will lower total compensation for 175 employees by an average of 50%, these people said. As expected, the biggest cut will be to salaries, which will drop 90% on average.

The administration also is attempting change the rules of corporate governance for these firms.  This is a better use of government resources if new rules are guided by good research.  Deborah Solomon continues with her description of the administration's plans.

At the same time, Mr. Feinberg will demand a series of corporate-governance changes at the firms, including splitting the positions of chairman and chief executive officer; requiring boards of directors to create a committee to assess risk, and eliminating staggered boards...

The Obama administration gave Mr. Feinberg the job of more closely tying compensation to long-term performance, something the White House believes will help prevent employees from taking unnecessary risks for short-term gains. The administration has made the case that skewed compensation incentives were one cause of the financial crisis.

I do not agree with the assumption provided below that employees of these firms were taking "unnecessary risks for short-term gains."  It is more likely that they miscalculated risk rather than ignored it.  They securitized mortgages, which economists, financial analysts, and regulators believed reduced risk.  Following Basel rules for capitalization, banks wishing to increase leverage could have purchased AAA or higher earning but riskier AA rated asset backed securities without increasing capital requirements.  Eighty one percent of securities purchased were AAA and only nineteen percent were AA (Friedman, Jeffrey, "A Crisis of Politics, Not Economics: Complexity, Ignorance, and Policy Failure," Critical Review, 21(2-3)).  They mismeasured risk not ignored it.