Twofish's Blog

February 5, 2009

CEO Pay Caps

Filed under: finance — twofish @ 6:28 am

A lot will depend on the details, but I think you can structure it so that it leads to good incentives.  The system that Obama seems to have in mind right now is if you take government money, you get punished for it.  If you are a CEO and you get your company in a situation where you have to take government money, then your salary gets cut to $500K.  I think this will work if there is a flip side which is that if you are a company in a situation were you *don’t* take government money, then you can pay yourself whatever you want.

If you have a situation in which a CEO that takes government money is limited to $500K, but one that pays back any loans can pay themselves $10M, you have a CEO that is very strongly incentivized to make a profit, pay back the government, and then two seconds later pay themselves $10M.

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3 Comments »

  1. Great post. This is really common sense logic. Unfortunately, too many people become emotional about the salary cap.

    Comment by Alan — February 5, 2009 @ 8:02 am

  2. I’m extremely emotional about it myself. What really worries me is the scenario in which CEO pay caps result in pay caps for everyone else working in finance, like …. well…. me….

    A lot depends on the details. What I think would be bad would be permanent caps, and one of the good things about the Obama action is that it prevents caps from being introduced in Congress where it would be difficult to undo. As it stands, if the economy improves and the banks pay back government money, then the caps can (and should) be removed.

    The philosophy that I’d like to propose is that a competent CEO that generates economic value really does deserve obscenely high salaries. If someone generates $1 billion in economic value, then a $10 million/year salary is a small price to pay. So as I see it, the problem is not CEO pay, the problem is incompetent CEO pay, and if you are forced to take money from the government, that is a sign of business incompetence, and having a salary cap is punishment for getting yourself in a situation where you have to take government money. If you don’t take government money, pay yourself $10 million a year. If you do take government money, well then Uncle Sam has a few conditions.

    This nicely gets rid of the moral hazard problem since if the CEO knows that they are going to get a massive paycut if they take taxpayer money, then are going to move heaven and earth to avoid that from happening.

    Also, I don’t think that there will be a shortage of people lining up to be CEO. If you pay someone $500K with the understanding that after they pay the government, they can pay themselves whatever they want this actually makes capitalism work better.

    Comment by twofish — February 5, 2009 @ 8:21 am

  3. A company performance can be 90% credited to CEO who enjoy authority to direct policies. Consider a scenario, A becomes CEO of X bank in 2001 to earn good bonuses, he need to show good profit. He fires thousands of Americans to offshore work and invests in riskier assets (good loans are assets while bad loans are liabilities) and book profit (assuming not cooking in between which is criminal offence). He basks in glory amongs investers while cursed by laidoff employees. In 2007 he reached a point where he cannot layoff more, so no scope of cost cutting (hopefully he’ll not undercut his salary) and he quits smiling with exit bonus and pensions. His successor comes in 2008, sees with horror that most are bad assets while he can’t do much on cost cutting. Who will you blame A or B?

    THINK

    And I am Indian with background in outsourcing factory and feel morally obliged to speak truth.

    Comment by Murk — February 28, 2009 @ 9:04 am


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