Google+
Close

The Corner

The one and only.

Limits on Executive Comp: Where I Think We’re Headed



Text  



Potentially to a good place, surprisingly enough.

The instinct behind the new restrictions on executive comp for banks receiving exceptional public assistance is sound enough: People on the public payroll shouldn’t be making $10 million per year.

The regulation, as far as I can see from a quick read, will obviously need to be fleshed out, and much of this will likely happen in a legal and regulatory back-and-forth based on individual cases. This will not be done in isolation, but will be closely bound up in a broader, unpredictable process of financial regulation over the next several years.

Ultimately, I think that the right regulatory framework for the U.S. financial sector is a modernized version of something that emerged from the Great Depression. My vision is one of, roughly speaking, tiers of financial alternatives of increasing risk, volatility, and complexity available to any appropriate investor. Almost any non-coercive transaction should be legally permitted in some context. The tiers should be compartmentalized so that a bust in a higher-risk tier doesn’t propagate to lower-risk tiers, and the government should be rigorous about allowing failure in the higher-risk tiers. I’ve called this idea “Walls, not Brakes.”

Something like this should provide the benefits of better capital allocation, continued market innovation, and stability. Of course, such a vision will never be fully realized. Markets constantly undermine such regulatory schemes. There is no substitute for ongoing, democratic evolution of regulations, unfortunately usually in response to failures.

The proposed limits on executive pay, if they have any teeth as they are really implemented, are likely to have several knock-on effects. People who are able to make millions per year in a competitive market will tend to drift away from these firms (even though these restrictions only apply to senior executives, they would change the compensation culture for the firm as a whole), and form new asset management firms, M&A advisory boutiques and so on. Along with limits on comp, the government-sponsored entities will have restrictions on investment behavior imposed by the government–they will not be issuing a lot of credit default swaps. This will mean these large institutions will be unable to offer very high rates of return as compared to the firms that don’t take government money, but will offer safety.

Think of what we would then have: A tier of government-supported, low-risk/low-return big commercial banks that are run by competent, but not exceptional, bankers who are paid like senior civil servants; and another tier of high-risk/high-return financials that look like the “old Wall Street” that everybody says is dead. This is a world of walls, not brakes. When this tiering is in place, the government should be able to get out of the business of doing things like directly setting executive compensation.

The downside risks to how this might develop are numerous. One is the potential that this low-risk tier will be literally a government-run utility for a long period of time. Another is that government intrusion on behalf of the government-supported banks is so extensive that it is impossible to compete without government assistance. There are surely others.

It seems to me that the key political debates on this topic are most likely to be around these kinds of issues. I think that the tiered vision for financial regulation of I’ve put forward makes sense, and is rough roadmap for transitioning out of direct government operation of businesses as rapidly as is prudent.



Text  


Sign up for free NRO e-mails today:

Subscribe to National Review