Misdirected anger over executive pay
ANGER in Europe over executive pay is finding its way into legislation. The European Parliament, backed by almost all of the European Union's finance ministers, plans to cap bankers' bonuses, and 68 percent of Swiss voters endorsed a referendum initiative to ban "golden parachutes" and put other curbs on bosses' pay. Agitated voters, grandstanding politicians and intelligent policy rarely go together, and this is a case in point. Let's agree that people are right to be disgusted. In the last decade top bankers led the world into the deepest economic slump since the 1930s, and their firms had to be rescued by taxpayers, yet the culprits aren't exactly suffering. In most cases they still have their jobs and by ordinary standards they're still outrageously well-paid. Bonuses -- whose purpose, one is always told, is to reward excellent performance -- have fallen but are still being handed out.
Meanwhile, lower down the capitalist food chain, workers are being laid off or told to take pay cuts. It's tough out there, say chief executives calling in from Davos, and we all have to make sacrifices. Absolutely, say Europe's ministers of finance; that's why we have to cut essential public services and raise your taxes. Considering the complacency, lack of contrition and in many cases sheer nerve of those responsible for the calamity of the past five years, the miracle is that the popular backlash against capitalism has been so mild. But being morally in the right isn't enough. If policy is to serve voters' interests, rather than merely gratify their anger, it has to be carefully designed. These initiatives aren't.
The first question is whether it's wise for the government to have any kind of say on how firms pay their executives. Straight away there's a crucial distinction -- between banks and financial enterprises that enjoy an implicit public subsidy (through the prospect of a bailout if they get into trouble) and ordinary public companies that don't.
Regulatory reform has pared back the subsidy for banks but hasn't eliminated it. If taxpayers are exposed to losses, regulators are not just entitled to monitor and curb the risks that banks are taking -- they're obliged to. This obligation includes regulating pay structures, since those can influence the amount of risk a bank takes on. So doesn't capping bonuses, as the European Parliament demands, serve that purpose? Not really. It's bewildering, first of all, that Europe's parliament is insisting on bonus caps in return for consenting to new international rules on bank capital. Requiring more capital is the best and simplest way to reduce the banking subsidy and hence the incentive to take undue risks. The new rules don't go nearly far enough in this respect. Rather than calling for them to be strengthened, the parliament wants a concession on bankers' pay. Go figure.
The parliament wants to limit banking bonuses to 100 percent of salary, or 200 percent if shareholders approve. There'll be loopholes, of course, but for the sake of argument let's assume they aren't exploited and the policy works as intended. Banks will simply fold average variable pay into basic salary. Most likely, such limits won't do anything to cut bankers' pay overall, the very issue that upsets the public. Reducing risk is a legitimate purpose of the policy. But too-timid capital rules mean that banks will still be run on the basis that employees and shareholders get all the upside of dangerous investments, while taxpayers are on the hook for part of the downside. The underlying problem isn't addressed.
One remedy, if capital rules can't be suitably strengthened, is not a cap on bonuses, but rules that lock them up and grab them back if things go wrong. Bankers should be made to retain a stake in their firm's losses. Big bonuses relative to basic salary -- so long as they can be clawed back -- would serve that purpose well. Yet the EU appears to be ruling out this strategy.
The Swiss vote is directed not at banks specifically, but at public companies in general. Where subsidies aren't involved, the starting position is very different. Unless you think the market for executives is fundamentally broken -- which I don't - - pay is a matter for directors and shareholders, not the government. Concerns about inequality are best addressed through adjusting taxes and public spending rather than by micro- managing executive pay.
Yet you can't help but notice that shareholders aren't always good at holding to account the managers running their companies. Well, you might say, that's the shareholders' problem -- but if public policy can help to align managers' interests with shareholders', that does serve the wider purpose of making capitalism work more like it's supposed to.