President Obama wants government to regulate the pay of executives of all financial-services firms – and maybe even of all publicly traded corporations – not just of those firms that received government bailout or stimulus funds.
Proponents of Obama’s proposal suggest that if government limits the pay that banks and brokerage houses offer their executives, these firms will have lower costs. These lower costs will mean better deals for customers, such as lower interest rates for borrowers and lower brokerage fees for ordinary citizens who buy and sell stocks. What can be the downside of such regulation?
Because it’s not our money. If the CEO delivers good value in return for his salary, the firm flourishes and the owners profit. If the CEO doesn’t deliver good value, the firm flounders and the owners suffer losses. Owners have no more interest in overpaying the executives they hire to manage their firms than homeowners have in overpaying the repairmen they hire to fix their leaky basements.
So why do owners of firms pay their executives so lavishly?
In the 1980s several states passed legislation making “hostile” corporate takeovers more difficult. A hostile takeover is one that incumbent managers disapprove of._At the time, Henry Manne, then dean of the George Mason University School of Law, warned that these “anti-takeover” statutes would cause executive pay to rise.
Entrepreneurs need flexibility, Manne explained, so that once they take control of a business, they can fire the current crop of managers (who might be overpaid) and replace them with better, and possibly cheaper, ones. Protected from these “corporate raiders” thanks to this legislation, many incumbent managers did in fact manage to take home excessive salaries.
There’s another reason top corporate executives are paid handsomely: They are worth it. Managing a firm is difficult, and the talent to successfully perform these difficult tasks is rare and very valuable.
How many of us could oversee organizations employing thousands or even hundreds of thousands of employees? How many of us have the judgment necessary for deciding when to expand a product line, close a factory, or relocate a headquarters? How many of us have the people skills required to ensure that teams of workers perform together productively, day after day?
The honest answer is “not many.” Landing top executive talent rather than only middling executive talent can raise a corporation’s net worth by billions of dollars. The result? Companies compete vigorously for this top talent through higher salaries.
Top talent can make all the difference between success and failure. Outside of a significant pay increase, a top executive has little reason to leave a post at a company that faces relatively little uncertainty and turmoil in order to join a firm facing lots of uncertainty and turmoil. If government steps in to prevent this incentivization, businesses could shutter.
Donald J. Boudreaux is professor of economics at George Mason University, and senior fellow for economic policy and tax reform at the Virginia Institute for Public Policy.
