Wrong Way To Cap Pay


Of course it is outrageous for bankers, brokers and traders to claim enormous bonuses while their companies operate on taxpayer life support. But working out the right way to limit Wall Street pay is important. It’s a lesson we’ve learned again and again through our economic crisis: it’s not enough to do something; you have to do the right thing. Or, at the very least, you have to not make things worse.

Lucian Bebchuck, who was perhaps one of the most famous critic of executive pay long before the current crisis, tears into the blindingly stupid restrictions on pay that were shoved into the stimulus bill at the last minute by Connecticut Senator Chris Dodd. The new plan is far worse than anything President Barack Obama proposed, and may end up leaving out bailed out banking institutions even sicker than they are now.

  •  Destroys Incentive Pay Structure. While Obama proposed restricting pay that was unrelated to performance, the Dodd plan hits incentive compensation, limiting it to one-third of total pay. This will just make executives less interested in the long-term overall performance of their firm, by sapping their financial incentives.
  • Mandates Restricted Stock For Incentive Comp. Awarding restricted stock for top executives, who have broad responsibilities for their firm’s performance, makes sense. But prohibitting other firms of incentive pay for lower level employees, who participate in their company’s performance in only limited ways, is a recipe for trouble. Their pay should be limited to making their unit perform well. We want managers to concentrate on a bank’s overall performance. We don’t want a stock broker second guessing a bond trader. It’s sure to lead to organizational chaos.
  • Pay Caps Encourage “Betting The Bank.” Germany attempted to require restrictions on pay for banks that took public bailout funds. It quickly discovered that many bankers would rather risk their bank failing than accept pay caps. “This encourages the managers to bet the bank – heads I win (and get paid), tails you lose (bank goes bust),” law professor Larry Ribstein writes. Except to see banks rushing to pay back TARP, paying themselves billions in bonuses all over again, and then creating the specter of failure.
  • Restricted Stock Also Encoruages Betting The Bank. “Consider the case where an infusion of additional capital would greatly dilute the value of common shares but would be best for the bank, while failing to get that capital would put the bank’s future at risk,” Bebchuck writes. “In such circumstances, compensation in restricted common shares would provide executives with an incentive to avoid raising capital (which would wipe out their shares’ value) and gamble on survival without additional capital.” In short, once again its a smarter bet for a banker to risk his firm for personal gain than accept limited gains for a more secure balance sheet. If that strikes you as insanely risky, you probably don’t work on Wall Street. Top bankers didn’t get to be that way by being afraid of risk.