Will Pay Caps Encourage Greater Risk Taking?


The pitchfork crowd may be pleased with the new pay caps on companies taking exceptional assistance from the government, but as WSJ’s Jason Zweig, there’s a little something called the law of unintended consequences that may make us regret or our desire for justice.

In addition to the potential loss of high quality executives — something that Ken Lewis has warned about — we may end up encouraging greater risk taking, the exact thing we want to avoid:

Finally, the new rules from the Treasury Department permit Wall Street’s “senior executives” to get incentive pay in the form of preferred stock that can’t be cashed in until the taxpayers get their money back. But there s no rule yet against cashing all of it in at that point — what compensation experts call cliff-vesting.

Thus, managers may be tempted to take greater risks in hopes of speeding up their preferred-stock payoff. If the risks go bad, Uncle Sam will eat the losses. “It’s the classic trader’s option,” says George Wilbanks, a managing director at executive recruiter Russell Reynolds Associates: “Heads I win, tails you lose.” He adds, “That’s my biggest fear: that people are going to swing for the fences to get to the cliff-vest faster.”

Of course, this is something that Ken Lewis would never talk about in an interview. You can’t admit something like that. But if you don’t think that’s a real possibility, then you haven’t been paying attention to the whole crisis.

Via Larry Ribstein, who goes further into depth on the potential negative consequences of the pay scheme.

See Also:
Ken Lewis To Maria: No Fan Of Pay Caps, Won’t Need More Gov’t Cash