The problem with executive pay is not the size but how they earn it.

The ongoing political furor about gigantic executive pay packages is largely misdirected at mechanisms for capping compensation. I have pointed out here and here that much of this has been abusive rent-skimming from captured institutions and manipulated markets. However, I see these as only shareholder rights issues because the macroeconomic impacts seem tiny. For example, ousted GM CEO Rick Wagoner's total compensation of $14.9 million in 2008 was 0.01% of COGS ($2 for a $20,000 vehicle), and Jeff Immelt's compensation equaled $48 for each of GE's 323,000 worldwide employees (2.4 cents per hour).

Even the astronomical paydays in the financial economy have little impact on the real economy until a big bust occurs. I doubt the pay practices on Wall Street have changed much since the investment banks went public about 10 years ago, but they may have started taking bigger risks when they stopped playing with their own money. The problem for us ordinary folk is not that they got paid so much but that their compensation contracts incentivized them to take grossly imprudent risks and were generally focused on very short-term revenue or income metrics.

This Working Knowledge article quotes liberally from three HBS professors and makes lots of sense about solutions as well as providing a good background. The background includes counterproductive changes in the law the last time we got exercised about excessive executive pay. Let's do something effective this time and not just enact a sop to populist rage.

Update on Monday, September 21, 2009 at 03:40PM by Skeptic

The Conference Board is out today with a report recommending businesses reform themselves on executive pay practices instead of waiting for regulation.  The report was drafted by a committee headed by Los Angeles lawyer Bob Denham and is available here.  Marketplace has this summary and some reactions. 

Update on Thursday, October 8, 2009 at 05:52PM by Skeptic

Nell Minow's career fighting profligate pay packages--including her own father's--is described in this New Yorker article.  She is concerned about misalignment of pay and performance, but also seems offended that typically executives are generously paid even when their performance is disastrous for the shareholders. 

Update on Tuesday, October 13, 2009 at 05:41PM by Skeptic

Yves Smith has this fine post to the same effect at Naked Capitalism:

Pay is the wrong way to tackle this problem. It’s a lazy, crowd-appeasing, intellectually dishonest approach. The out of line pay is a symptom, and any attempt to treat symptoms as causes is likely to be ineffective, more likely dysfunctional.

. . . .

The financial services industry now has an unimaginably rich deal: privatized gains and socialized losses, and with tons of leverage too, which amps up the apparent profits and hence the pay levels these looters can claim they deserve. The way to attack this problem is to constrain the level of risk assumption. That in turn requires understanding the products and the markets, something the authorities have completely abdicated. With so much “talent” looking for jobs, now would be the perfect time to invest in catching up.

Comments

[Christine]

Roger, I don't think that this deals with the real problem. Take, for instance my brother's rage about the pay of the American Airlines execs. He's a pilot and he is earning, effectively, the same wages he was in '73. He is furious that they have negotiated down the pay increases for unions, and asked pilots and others to take cuts while lining their own pockets. I'll bet that the situation is the same in much of the rest of the working world. This is a matter of basic unfairness. Why are worker wages stagnant, while the boys at the top are raking in big bucks? All wages are not equally stagnant, and you would have a hard time convincing me and almost anyone else that there is higher productivity among the failed industry execs who are asking for taxpayer money...etc.

The issue isn't how much the pay at the top is, the point is that it is outrageously, offensively excessive in light of what the same scum are doing to their own workers, and that includes the massive Wall Street layoffs. There is a further problem for democracy, and national work ethics and morale when the rest of the country struggling to get along sees the failures at the top setting themselves apart as a privileged class of walled monied interests that are bad for almost everyone else in one way or another. These are very real problems. Not the $2 per car that those salaries cost.