Why it’s hard to limit executive pay

Matt, Ezra, and Bob Frank, among others, have been talking about this topic.  Say we taxed rich bankers at 95 percent above a certain income level.  Salary income would be converted into capital gains.  We don't want to tax capital gains at 95 percent or even 50 percent.  Plus taxing unrealized capital gains — if you desire that the earners cough up the money now — involves other problems.

Of course some firms and sectors cannot equitize pay in this fashion.  A big implicit tax is then placed on such sectors.

You could work very hard to develop a tax code that will cover exactly the people you wish, at the margins you wish.  You could work very hard and still fail.

Looking for "longer-term incentives" is a sounder approach than trying to force "much smaller incentives."


Call me a nut, I think we tie wages to one another. Boards can award execs with whatever compensation they see fit but that amount must be a fixed percentage of the lowest paid wages in the organization. (for instance, total value of compensation for an executive can only be 1000 times the wages of the lowest paid employee) This could be made more flexible by, say, having different fixed percentages for companies of various sizes (as measured by total employees) or value.

The problem with my idea is that it would promote subcontracting low level jobs (what I hope the incentives to having a bigger company would help reduce), of course the subcontracting company would need to honor the same wage percentages.

I remember reading somewhere that JP Morgan fixed the wages of his upper managers in a similar way, but I don't know the details.


The problem with that is that the standard you're presenting has little if any correlation to what makes a CEOs job hard, and doesn't promote higher tax revenue, which is what the proposal was trying to do.

The CEO of WalMart would have a relatively low salary, as compared to the CEO of a biotech firm, even if the CEO of WalMart has many more managerial duties and creates more value than the biotech CEO.

And anyway, the goal of the 95% proposals is to bring in government revenue. A flat salary cap does the opposite. Also, it's a pretty clear violation of the due process clause, because it regulates companies in an uneven way.

I think we limit executive pay by changing the structure of corporate boards. Right now, being on a corporate board is cushy job whether or not the company does well, so the board members' main incentive is not to fail. This leads boards to overpay for proven executive talent even when developing from within would be more efficient in the long term. If most companies act like this, there will be a shortage of proven executive talent, leading to even higher prices. I don't know how we change corporate governance, but I feel that executive pay is a symptom of a warped risk/benefit decision at the corporate board level.

Umm...Why don't we want to tax capital gains at 50 percent?

Shouldn't libertarians -- who claim to want to cut red tape, simplify government, etc. -- believe that all income, regardless of source, should be treated the same by the tax code? If the top tax bracket were to be 50 percent, why shouldn't all income at that level be taxed the same?

songar: The market has dealt perfectly well with Wagoner and GM -- their cars suck, nobody wants them, and their sales have gone over a cliff. When the government dumps another eleventy billion taxpayer dollars into that black hole, I hardly think the market will be at fault.

If someone is being robbed by high executive pay, then it is the shareholders being robbed, and no one else- not the workers, not the customers, and certainly not the government. However, note who gets the money in these proposed “solutions† to high executive pay.

GM customers weren't being robbed when overpaid executives continued to produce substandard products?

Shareholders weren't being robbed as the value of their portfolio continued to drop over the last 8 years while Wagoner continued to receive salary and bonuses? Where were the (also well-compensated) board members in this equation? Whose interests were they representing?

Where's the opposable thumb on the invisible hand in all this?

I agree with the first comment by missedcall. Limit executive pay by relating it to lowest full time worker's pay in some way. However missed call is saying something like 1000 times lowest workers salary, I would say more like 20 times lowest paid worker's pay. IMHO no man is worth more than $500,000 a year. Also this would free up much needed capitol to make USA companies much more competitive.

Require any pay above $1M in any form to be matched by an equal notional value of total return swaps linked to the company's stock that are not transferable for 20 years. The NPV of this total return swap will be zero. If their stock goes down, they will OWE money. They will then demand high salaries to compensate that will be taxed as ordinary income, and be very cautious about how they perform and their successor.

Maybe then they will actually attempt to produce value for the company rather than worry about 2 years of profits and their next years bonus.


The Williams Act (which again, made "hostile" take overs more difficult) handcuffed the invisible hand's ability to constrain executive pay, and/or the actions of boards of directors. The consequences of the Williams Act are because of the handcuffs it puts on the invisible hand. Granted the invisible hand's benevolence is difficult for many to see, but come on, my explanation should be the equivalent of night vision gear.

Of course if you are a true believer in government planning, you will remain blind; by definition, true believers are impossible to persuade even by rational argument and/or evidence.

interesting here are the parallels between the auto industry and wall street.

ie major stakeholders looting their companies from the inside.

this has gone on transparently, over time.

it seems like shareholders and boards are the natural first line of defense against this. are they legally eviscerated?

babar says: it seems like shareholders and boards are the natural first line of defense against this. are they legally eviscerated?

The problem is that shareholder power is too diffuse to constrain the corporation in most circumstances, and that boards become creatures of the CEOs rather than the stockholders. Shareholder control of corporations, like citizen control of government, is a very blunt instrument. In practice, only extremely wealthy individuals or institutions can force out management - and those individuals/institutions also typically have interests not aligned with those of the rest of the shareholders.

We like to think of corporations as synthetic individuals, but it's probably equally true that they are special purpose extensions of governmental power.

indianajim: If the Williams Act (there are ways of getting around that, aren't there?) is all that's holding back the invisible hand from doing its job, why didn't Phil Gramm deal with it when he had Glass-Steagall repealed. Problems solved, right?

Are there ways around the Williams Act or not?

"what are the odds that there has been only ONE flawed* bit of legislation?"
Dunno. Odds recently that there could be more than one corrupt or inept CEO receiving millions and millions in salary and compensation seem pretty high. Maybe an unflawed** "bit of legislation" (if you believe there is such a thing)could rectify that problem.

*(**)I'm of the opinion that every bit of legislation,like every person who contributes to its creation, is likely to be flawed in some way or other.The alternative, if you're looking for legislation without flaws, would seem to be no legislation at all.

I'm happy (perhaps not all here are) that we live in a nation governed by laws. And I wouldn't be averse to trying out some government regulation of exec. compensation. After all, someone like Phil Gramm can always come along and have it repealed, if he thinks it doesn't work.

Songar, Mike S et al...

The criticism of the free market "failing" because Wagoner was paid too much is silly. The free market is no guarantee that bad decisions won't be made, just that they'll on average be punished. Given that you think that the firm of GM made a bad decision in the compensation of Wagoner, where would GM now be without government intervention?


You talk of "solutions". As Thomas Sowell put it, there are no solutions, only tradeoffs. Put your faith in people spending other people's money on yet others if you like, the evidence sides with Friedman that: no one spends someone else's money as carefully as he spends his own. The pursuit of self interest often leads as an unintended consequence to advancement of the wealth of a nation; this was Adam Smith's hypothesis and the evidence of history supports it.

Your assertion of MY blindness is false and you know it (that you make you disingenous); show me evidence to the constary of the wisedom of Sowell, Friedman, and Smith and I open to hear it.

Laissez Faire.

All this government meddling will lead to nothing but trouble.

If we the people own their a$$es (e.g. Ford, AIG), then our elected representatives can do whatever foolish things they want.

If the governmental drones do not own a controlling interest, neither the executive nor legislative branches have any business dictating to businesses how they should run their business or compensate their employees.

As a distinct carve out to above, certainly "good" regulation constrains how business are run, and is acceptable. But "bad" regulation about how much money a CEO can make, or socialistic ratios between ave:CEO or lowest:ceo are just plain anti-American in my opinion

We need a cap on the intelligence of people who suggest market interference. But ahhh, I repeat myself.


So by your reasoning, being a CEO of an investment bank has an NPV of 0 or even a negative NPV? On average, for a CEO, there is great personal reward for bad decisions.

The banks need roughly $1T of money to be solvent. Either the US taxpayer will pay it or someone else. So how did these CEO's walk away with a few hundred million?

The point is that the people that make bad decisions at the top have little or no punishment for their bad decisions. They do not walk away broke. They do not walk away owing a few hundred million dollars and living in Hammond, Indiana.

The invisible hand only works if there is some downside. There is not any worrisome downside to being a CEO of a car company. Oh no - I might have to go to walk away with a $15M golden parachute and work in private equity for $1M a year! Holy hell, what are we going to eat, honey?

If the SEC requires that stockholders have the ability to vote, each year, on the CEO's pay -- and if they vote it down, he *doesn't get paid* -- you will see CEO pay become much more reasonable very very quickly.

It was pointed out here some time ago that the salaries of CEOs of companies owned by private equity firms are quite high -- I'm not sure there's any difference with public companies when controlling for different variables. Maybe there is a crony capitalism explanation for this but I haven't seen it yet.

Why exactly is high executive pay a problem? The comments here make it clear that what people see as needing a solution is executives getting too much compensation not the existence of rich people per see or the lack of sufficiently progressive taxes. The lack of any apparent need to link the 'problem' to any actual disutility being caused makes me suspect this is really about resentment and the desire not to see "unworthy" people live very well not any actual desire to improve anyone's life.

Now don't get me wrong. I agree there is a problem in corporate governance but it's not a problem of executive pay but of executive talent. All somehow capping executive pay would achieve is to save a few tens/hundreds of millions at huge companies. But that's on the order of the amounts at issue in the daily deciscions of these executives. Just choosing the executive who makes the right call on whether to institute diversity apprecation or if they should allow employees flexible working hours rather than the wrong one is probably worth that kind of money right there. It seems to me that if one wanted to stop waste one would probably be better off advocating boring things like process tweaks, more aggressive trimming of redundant employees/systems and optimum network design than stopping the payout of huge salaries to the very top executives.

What is a big deal is the fact that neither boards (nor those who appoint the board) do a very good job at selecting the better executive talent. Even a very small improvement here could result in massive efficiency gains.


Ohh and the problem with many of the suggestions above is that they encourage the very behavior that was so troubling in the banking sector. The more you tie executive compensation to stock or to any other short term indicator the more you will encourage risky behavior. No one will work for you if you demand they agree to forfeit all their savings if the stock price/whatever tanks so any compensation scheme will have a floor of $0. Thus the obvious strategy to generate wealth then is to simply increase the risk the company takes.

Regarding the Williams Act...


"We investigate the impact of changes in states' anti-takeover legislation on executive compensation. We find both pay for performance sensitivities and mean pay increase for the firms affected by the legislation (relative to a control group). These findings are partially consistent with an optimal contracting model of CEO pay as well as with a skimming model in which reduced takeover fears allow CEO's to skim more. We compute lower bounds on the relative risk aversion coefficients implied by our findings. These lower bounds are relatively high, indicating that the increase in mean pay may have been more than needed to maintain CEO's individual rationality constraints. Under both models however, our evidence shows that the increased pay for performance offsets some of the incentive reduction caused by lower takeover threats."

The problem as I see it is with voting rights within the corporation. By controlling a small percentage of the company stock, perhaps as little as 5%, the executives running the company can control the voting. That, along with the good old boy cronyism on the board, enables them to grant themselves lavish compensation despite protests from the vast majority of shareholders. The fix is one shareholder, one vote. The notion that it's necessary to pay bonuses in the millions to retain qualified people is absurd and insulting.

"We don't want to tax capital gains at 95 percent or even 50 percent."

Speak for yourself! Here's my proposed taxation scheme for capital gains:

1) Long-term, inflation-adjusted capital gains should be taxed as regular income. (The only convincing reason I've ever seen for NOT taxing cap gains as regular income is that much of the 'gain' is really just the decline in value of a dollar over time. Adjusting for inflation fixes that.)

1a) And I'd be all for brackets of 50% or higher to apply to the super-rich. If you earn $100,000,000 in a year, why should you be in the same tax bracket as someone who earned 'only' $400,000?

2) Short-term cap gains should be taxed at the following rate: the higher of (99 - number of days the asset is held)% or regular income. (A gain would be long-term if your marginal income tax rate is higher than the number in parentheses.) So if someone held an asset for 7 weeks or less, they'd be taxed at 50% or more on the gain. Can't see that that would be a problem for anyone besides speculators.

Comments for this post are closed