Up Front

Pay Limits: Not Smart

Douglas J. Elliott

The government just announced two sets of actions to constrain the compensation that banks pay to their top executives. First, Kenneth Feinberg, the administration’s “special master” for compensation at the handful of companies that were most thoroughly bailed out by taxpayers, just announced the agreed compensation levels for the top 25 executives at each of those firms. Compensation levels were halved compared to the banks’ requests and a very high percentage was redirected into company stock instead of cash. Second, the Federal Reserve (Fed) announced draft guidelines to avoid compensation practices that might encourage banks to take excessive risks. Here are my brief thoughts on both:

1. Feinberg’s executive pay plan. Since taxpayers have such a big stake in the success of these companies, I think the main test should be whether the actions are those that a smart private owner would have taken. I think they are not, since they send the wrong message to the people working there or considering working there, which is that their pay will not be determined the same way as on the rest of Wall Street and will be considerably lower and more volatile. This risks losing the best people, since the ones that move are always those who have the best options elsewhere. That said, the plan could have been considerably harsher, so this may be the best we could hope for, given the politics.

2. The Fed’s plan is a good one, but I wouldn’t expect big changes as a result. They are focused on situations in which the compensation plan fosters excessive risk, which is very different from the populist concern about how overpaid bankers are. There is no attempt to limit total compensation levels, nor do I think the Fed should try.