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Boulton: Executive pay caps don't work

Boulton: Executive pay caps don't work

June 17, 2009
June 17, 2009

Liberals are ‘dismayed’ at what senior executives of the country’s largest companies are paid and the way they seem to waste money on themselves at the ‘expense of the shareholders’ and are morally outraged when harebrained ‘shareholder measures’ are given little consideration when brought to the floor during annual corporate meetings. Therefore they and President Obama feel obligated to protect little ole me, the chartered financial analyst, and my investments from rapacious senior executives. First, I and my ilk don’t need their ‘protection’ and we do our best to vote our shares in a democratic manner so that the maximum value of the corporation for the shareholders, whomever they may be, can be achieved as we perceive it.

That’s what’s in the vested interest of us and those we represent in a fiduciary capacity. Doing otherwise would be a breech of our fiduciary duty! Publicly traded corporations exist to increase the wealth of their stockholders – period. Corporate management is not supposed to be an agent for politically correct social policy at the expense of the shareholders financial interests and possibly this is what irks liberals the most. Besides, the relationship between shareholders, management, and labor consists of thousands of freely entered into arrangements by all participants in the extremely complex matrix that leads to the corporation that we know today is none of their business as long as the law is obeyed.

Despite the obvious, President Obama has appointed a tsar to investigate and come up with ways to ‘optimize’ executive compensation from the perspective of politically correct social policy – a concept that’s fascist in nature. Of course, being morally superior lawyers who’ve never earned a dime in the private sector, all the President’s men feel that they know more about the subject that all the boards of directors who have to find competent leaders to run their companies, the thousands of headhunters and human resource experts in employee compensation they hire to assist them, and so on. By sitting around a table debating executive compensation issues, these illuminati feel that they’re better adept at discerning the ‘perfect solution’ than the millions who participate in what’s only modestly an asymmetrical information market.

Just as absurdly President Obama’s executive compensation tsars feel that they can establish an enforceable compensation cap of around $400,000 for CEOs and end up with an economy that works to create wealth for all its citizens. First this ignores that inevitably once a price cap is placed on any good or service, and corporate management is a service rendered to stockholders, a black market for those goods and services will develop. When applied during World War II, companies resorted to compensating employees above the wage and salary caps by resorting to ‘soft compensation’ – perks like country club memberships and employee healthcare benefits. In other countries these caps are circumvented ‘under the table’ through mazes of ‘kickbacks’ and bribes – leading to cultures of corruption that many nations have no chance in hell of ever stamping out. Once the genie is out of the box, it stays out.

Also overlooked is that the labor market is a competitive market and demanding that most CEOs and their senior staffers undergo a horrendous pay cut would lead them to conclude that performing the arduous duties that being part of senior management requires just isn’t worth the effort. Good leadership is a rare commodity, something most of us quickly learn when we step up to the plate in the various organizations we belong to. We quickly see that most around us are perfectly happy to be followers and find ways to get bogged down on minutia to avoid having to face harsh realities.

Then there is that rare commodity – people who are comfortable making decisions. After college I entered an environment where everyone I associated with made decisions as a matter of course. If they had a problem in that area, they would have been privates – not commissioned officers. In that realm indecisiveness got people killed, and when that happened I and my peers were held accountable. Run that by the average bear and watch him freeze up in the pre-natal position. We were also held accountable if one of our genius subordinates screwed up even when we were miles away. Rank might have its privileges, but it clearly has its responsibilities and a lot of talented people back away from that.

So when I moved on, you can imagine what a shock it was when clients would hem and haw forever over ‘buy, sell, or hold’ – even if they were educated up the wazoo. Naturally my frustration levels tended to rise as I wanted to scream – Jesus, Mary, and Joseph, make up your mind now! But that’s not how most people function. Instead the natural inclination is to postpone decision making for as long as possible to avoid making the ‘wrong one’ in hopes that the problem would go away. The entire civil service is predicated on that, so when someone like me wanders in knowing that every analytical exercise is geared towards making a decision – even if it’s only ‘buy, sell, or hold’ – the fear factor in the room goes right through the roof.

So what are these intangibles worth in monetary terms to publicly traded companies? From what’s amply itemized in every corporation’s SEC filings – it’s more that $400k. Unfortunately for America’s future economic prospects, political correctness in the White House disagrees and if its denizens who’ve never worked in the private sector, with help from Congress, pursue a desire to dictate limits on executive pay, the future competitiveness of corporate America is in peril.

Talented people are going to voluntarily sell their services to the highest bidder and in today’s highly competitive global economy that could just as easily be the Sheiks of Araby, or the Peoples’ Republic of China. If compensation caps are set too low, anyone with of little moxie is going to work for non-American companies – leaving only the mediocre behind to staff brain dead American companies. (Corollary to Gresham’s Law: pound foolish and penny wise will drive out good managers).

Since there is a reason privates get paid less than lieutenants and no one gets paid more than the general, pay caps imposed on corporate CEOs force the pay of everyone else to proportionally line up beneath the cap according to existing pecking orders. Net-net, all compensation packages will compact towards the lower end pay scales, leaving talented technicians with PhDs wondering why they wasted the effort and average college graduates debating whether further education and training is worth it; or they too will simply pack up and move on to offshore companies whose pay scales are competitive with free market conditions and again leave the brain dead behind to slosh around in the void while seeking illegal financial incentives to augment meager salaries.

Thus, according to basic economic truisms, President Obama’s ‘pay tsar’ schemes to eliminate alleged and generally fictitious abuses in corporate compensation would serve to only deprive people of the ability to achieve small dreams (like making enough money to buy a wide screen TV) – not big ones like squirreling away enough capital to start their own companies. We’ve already seen how this works in the case of once industrially vibrant Sweden and amongst all the Asian ex-patriots who’ve migrated to Silicon Valley to start what are now some of America’s most prosperous high technology concerns. In fact, to escape to what are now becoming freer economic climates, we’ve begun to see these same people relocate their businesses and employ their talents in the commercial entrepots of China and India.

Once the price of anything is leveled by government decree below the equilibrium market price, the unintended consequences are painful as the Obama Administration apparently wants us to relearn. Remember, it was the Crown’s price controls below that point which did much to cost His Majesty the loyalty of Virginia’s tobacco farmers in 1775.

Addenda: Back in the 1970s and 1980s, the financial services industry was segmented into Community Banks created under the auspices of the Community Redevelopment Act, thrifts and loans (including credit unions), savings and loans, commercial banks, and investment banks which encompassed stock brokerage. That is also how comparative compensation packages lined up with Community Banks the lowest rung up until one reached Wall Street with a private office high up in the World Trade Center (the late ‘twin towers).

The basic premise at the time was that community banks represented affirmative action hires staffing what were viewed as marginal financial institutions surviving at on government regulatory assistance with guidance from more astute financial institutions. The thrift and loans confined their activities to collecting deposits and making consumer loans which was never considered a high skilled sport. Savings and loans represented the next step up with slightly improved compensation packages since the then bureaucratic world of home mortgages was a little more complicated compared to placing liens on family vehicles.

Those with MBAs and desireous of possibly making some real money populated commercial banks with the real ‘best and brightest’ moving on to Wall Street firms (investment banks). As one moved up these rungs, three things happened. First, obviously, the pay got better – but more and more of one’s compensation were predicated on measurable performance such as commissions, incentive fees, and ‘bonuses’ (actually a variant of commissions). Finally, as one got closer to the financial services industry’s top rung – a geometrically proportion of what one did was centered on the creation of intellectual product.

The last is why those working in the world of ‘Wall Street’ and on the front lines of servicing clients got the ‘big bucks’. It’s one thing to sit behind a desk and hand out auto loans. It’s quite another to sit down with wealthy clients and construct dynamic investment strategies that would work for them out of whole cloth. Figuring all that stuff out and constructing portfolios, then making adjustments to anticipate constantly changing economic conditions is altogether a different proposition.

That’s why for me, it was so much fun but I still had to adhere to all the industry’s fiduciary requirements with the constant risk of maybe losing a major lawsuit someday – something affirmative action hires in community banks never had to consider. Ergo, the product at the top end was created in one’s head and the financial rewards had to match the effort required and the risks – it’s not a ‘nine to five’ world. Otherwise one could have an easier life underwriting mortgage loans at the local S&L with the comfort of a modest but predictably consistently monthly paycheck.

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