Bankers’ salaries
In the wake of all this public anger over bankers’ salaries, and within weeks of taking office, Barack Obama is proposing “common sense” executive pay guidelines—at least in companies receiving government money. These measures call for executive salaries not to exceed $500,000; any further compensation could only be in the form of stocks, which can’t be sold until the government is paid back. No doubt this makes us feel better to some extent, but the question is, will it work?
I think not, and here’s why: if we were designing the stock market from scratch and offering people $500,000 a year plus stock incentives, I’m sure we would get lots of qualified people who would kill for this job, and not only for the salary but also as an important civil service to maintain the financial system on which we depend. But this is if we started from scratch, which we are most assuredly not. Instead we’re dealing with existing bankers who are accustomed to millions a year plus millions in stock options. These people have made up, over the years, a multitude of reasons why this is the least that they deserve for their efforts and skills (how many people can admit to being paid much more than they’re worth?). This is a problem of relativity. To these bankers, in view of their “normal” pay, it looks like an offensive and irresponsible offer. My guess is that they will not accept these conditions, or if they do, they’ll find other tricks to pay themselves what they think are “right” and fair wages, which is what they earned heretofore.
What would I have done if I’d been the financial czar in this situation? I would try to turn over a new leaf; incentivize the creation of new banks with a new pay structure; promote the idea that bankers are not greedy bastards but have a crucial social responsibility so that a whole new generation would take this approach and want these positions. The “old bankers” who feel they needed millions of dollars to do their jobs well could try and compete in this new market, but we’d see who actually wanted to bank with them when the alternative is a new bank with more idealistic underpinnings and a better, more realistic, and more transparent, salary structure.
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The minute I saw the salary cap I thought about the the lawyers that you used as examples in PI and wondered whether it would work. I suppose making the public decide who to bank with – old style or new style would make a difference provided the public got past their innate inertia and took action.
Well, I do think the cap is good, as it does serve as a punishment. But most surely, none of the executives will leave their jobs, due to the current market.
If they really cannot afford living with such an income, and they have to find a better position, they have been probably living beyond their means. And that tells a lot about the quality of advice you would get from such a banker.
And so we reach the compensation question. I don’t think we can come up with a fair compensation framework so quickly. We haven’t been able to do it for the past 200 years. And this new crisis does not bring anything new to the table. Just the insight that most of the world got carried away by the “growth talk”, and lived way beyond their means: from American households, to the American government, to the Eastern European economies, and other emerging markets.
The sad thing is, that most of the bankers did not realize in what kind of a situation they are. It’s understandable if the employees in the low key positions did not really get the whole image, but neither did the ones in the top spots.
So, should we compensate them for that? Maybe we should see the cap in a different way, a compensation for the services provided by the top management in running the daily operations, a base salary. The difference from the prior earnings would then be an performance pay, coupled to strategic decisions made in the current years, and previous two years. So Mr. Ariely, this could be a start for the new compensation scheme you are asking for.
PS: This model could also compensate top management for having made the decision to take governmental help, albeit, not in the current year, but in the following years, if the bank survives, and will turn out to be in a better situation.
Writing in the NYT a couple of weeks ago, the CEO of Netflix, Reed Hastings, suggested that bonuses should be unlimited, but all-source income over $1 million should be taxed at 50%. A relevant source is http://www.huffingtonpost.com/2009/02/06/netflix-ceo-to-obama-dont_n_164699.html
His argument was that every time we hear of a $20M bonus being given, we could all cheer that that would mean an additional $10M to the citizens/treasury. (Of course, this assumes that you believe, as I do and Reed Hastings apparently does, that government will do better things with that $10M than leaving it in the banker’s hands would.)
Possibly more psychologically appealing than a cap, especially when companies start framing their bonuses to include paying the tax on the bonus. On the other hand, a cap might have some psychological advantages in terms of social comparisons — once you’re at the cap, you know that there’s no one doing better than you (Well, no one in the US. Not counting restricted stock.)
Banks are unique institutions that serve a public purpose. Traditionally, banking — like other regulated industries — provided small, steady profits. The government offers banks the ability to create money by making loans, clearly a useful service. However, banks need to be highly regulated so that the government (taxpayer) is not put at risk.
The current crisis has been caused because banks were allowed to stray from their traditional role. Had they functioned according to the traditional model, they would not now be insolvent. However, they were permitted to speculate in securities. This provided opportunities for huge profits, allowing gigantic salaries to their managers. Because executives were gambling with other people’s money, their risk taking wasn’t restrained.
Policy makers should decouple banking from speculation in securities. This would eliminate the issue of high salaries because banks couldn’t generate massive short term profits. Of course, better managers who operate traditional banks more efficiently and engage in wiser lending have more profitable bank and receive modest rewards. However, banking is not rocket science. We need competent people to run banks but we do not need geniuses. Never again should banks be allowed to become like hedge funds.
Fundamental change is needed immediately. It has been reported that banks have used the TARP money in recent weeks to engage in enormously risky speculation. If the bets pay off, the managers will be rewarded but they can’t lose if the bets go sour. As long as bankers can speculate, we are all in trouble.
The big money center banks are insolvent and they need to be nationalized immediately. All of the executives should be removed and replaced by competent bureaucrats paid decent, but not lavish salaries. The banks should then be operated for the public purpose.
I agree with you that it won’t work. A better idea is what has been discussed lately about “Nationalizing” the banks that matter, fixing them and then selling them to the private sector.
Injecting money in banks without ridding them of the original cause of their misery will not work.
I like the “Stress Test” that the treasury department is suggesting.
i love that you used the word “bastard!”
your book’s great!
I don’t think it will work either. They’ll find ways around any seemingly perceived “unfair” caps. It’s like pro athletes: it’s not how much they make, it’s how much they make relative to each other. Just finished reading PI today–loved it!
I think the problem is that these executives actually believe they are worth their salaries and will simply find other ways to pay themselves the money so that their Egos are satisfied.
The real problem is that all of these companies are run by directors who aren’t really accountable to shareholders or owners. There is no real feeling of responsibility only accountability ie not getting caught is the same thing as being right. Very sad.
I run my own business and the feeling of responsibility that I have for it and my staff at times like this is almost overwhelming. Somehow I don’t see them losing any sleep at the people whose lives they have ruined.
The first problem is that we have completely lost track of what money is. It is an easily transferable representation of REAL resources. An interesting behavioral study could be done on this. Due to the nature of money we disassociate it with anything real and think of it has a limitless commodity; but we maintain the realization that the more money we have the more we can buy.
What if you simplified the equation with a small test group divided in to teams. Have a set of rewards for the participants. They are told they can bid on the rewards with some form of currency (designed for the test). Each team can make different amounts of the currency depending on how successful they are as a team. They must also decide how that reward is to be divided between them and their success will be dependent on a few individuals with unique talents and skill sets. How much will they be willing to pay those uniquely qualified individuals to participate in terms of the currency.
Do the same experiment with a second set of teams, but the rewards are divided directly with no currency involved. I suspect that the group dealing directly in the rewards without any currency will be less willing to dole out exceptionaly large rewards.
Back to central topic. I believe David is right, and the way to accomplish it is to allow the large banks to fail in an orderly fashion, and allow small innovative upstarts to consume them.
Rather than cap their salaries, just make the income tax 90% on all salaries in excess of $500,000. The real problem with the salaries and the bonuses is that the board of directors is paying with the stockholders’ money, so they have no personal financial incentive to make sure they get their money’s worth from CEO’s, etc. Just look how people with really important jobs, such as teachers, firemen, doctors, etc., are paid when they are paid by taxpayers, and those taxpayers will hold their elected officials directly responsible.
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