A couple of weeks ago, the Obama administration named attorney Kenneth Feinberg as compensation czar. (I must point out that it’s really not helpful to allow someone to be referred to as a “czar” when you have a bunch of people worried that you are trying to turn the U.S. into a socialist state. Just saying.) Feinberg’s job is to set compensation for top (as in the food chain, not as in performance) employees at firms receiving bailout money from the government. My initial thoughts:
- How on earth did I miss the application process for this position? It seems right up my alley.
- Why was an attorney chosen rather than an economist? There are plenty of very bright economists who specifically study contract theory and incentives. (My vote, for example, would go to Brian Hall for his work on executive compensation.)
I am not in principle against the government placing restrictions on bailed-out firms, since it seems only fair that the bailout funds could come with some attached strings. This stance is, of course, based on the assumptions that 1. The firms being bailed out made unintelligent choices in order to get themselves in trouble (and weren’t just victims of happenstance or bad luck), 2. The corporate oversight was lax enough to allow bad policies to fly under the radar, and 3. The firms knew in advance about the restrictions they had to agree to in order to take the money. That said, these attached strings should be designed intelligently so as to not strangle the compenies they are aiming to fix. I wrote before about how the $500K pay cap for CEOs of bailed-out firms was likely to be counterproductive. I stated two main points:
- The limits were going to lead to a “flight of talent” to firms that were not receiving bailout funds and could thus offer higher compensation.
- The limits were going to result in firms gaming the system to maintain their current levels of pay.
Apparently the compensation czar didn’t read the memo that I sent. (When will people learn? Sheesh.) From what I gather, limits on bonuses were one of the pieces of the czar’s plan for fixing broken companies. How do I know this? Because I read the following headline:
Excuse me for a moment while I register my lack of shock. Some highlights:
“Citigroup Inc. is increasing base salaries for many of its employees — reportedly by as much as 50 percent for some workers — as it restructures its compensation program amid new restrictions on bonus payments.
The increased salaries will offset lower bonuses, according to a person familiar with the matter who requested anonymity because the plans have not been made public. The higher salaries are not the equivalent of annual raises, the person added.
Citi faces restrictions on bonuses as part of a new government compensation oversight plan because the bank received bailout funds from the Treasury Department.
By shifting the mix in compensation packages, it will allow Citi to pay most employees as much as they received in 2008 while adhering to bonus caps.
‘Citi continues to examine ways to ensure its employee compensation practices are competitive in this very challenging market environment,’ Citi said in a statement Wednesday. ‘Any salary adjustments are not intended to increase total annual compensation, rather to adjust the balance between fixed and variable compensation.’
A New York Times report published Wednesday said some employees salaries will rise by as much as 50 percent because of the change in compensation structure.”
“The Obama administration has blamed compensation plans for encouraging excessive risk-taking that pushed the financial services sector into chaos last year.”
“Aside from the boost in salary to offset the lost bonuses, Citi is also planning to award new stock options to employees to help ensure they remain at the bank, according to the Times report.”
At least Citi is smart enough to recognize the possibility that people would leave if Citi stops paying them, and I would argue that it’s doing the best it can within the regulatory framework. But is the regulatory framework a smart one? As noted above, there is concern that variable compensation leads to excessive risk-taking. I’m not sure that I agree- in order for excessive risk-taking to be a concern, executives would have to either be protected from downside risk or be very risk-loving. Hm. When I put it that way (and think about bonuses in the form of stock options), it doesn’t seem so farfetched. Regardless, the purpose of variable compensation (read, bonuses and the like) is to align the incentives of managers and shareholders. Shifting to a more salary-heavy structure *may* discourage risk-taking (if you’re paid a salary, why not take the risks that seem interesting? It’s not like your butt is on the line.), but it will also likely discourage general usefulness and productivity. After all, the concept of variable compensation came about because a fixed salary wasn’t providing proper incentives to managers, so wouldn’t we want to figure out a better way to incent rather than just taking a step backwards?
I will acknowledge that the academic literature on incentives states that sometimes it’s better to not give an incentive at all than it is to give an incentive for the wrong thing or give an incentive that is too norrowly defined- after all, you very much get what you pay for. But what do you get when you pay for nothing?