Should the Government Decide Your Salary?

Barney Frank, March 18, 2009
Francis Cianfrocca is a Senior Editor of The New Ledger.

Yes, that's my question. Even though the week's headlines are about how much senior management should be paid, the real underlying questions are: can the government do this effectively, and should they be doing it in the first place? Because even though the pay arrangements of the best-paid people in American business are on the block now, the precedent for government input on salaries will be exceedingly easy to extend to everyone else.

In a publicly-owned corporation, executive compensation (the salary, bonus, perks, and other incentives granted to the most senior managers) is determined by the board of directors. Most boards have an independent compensation committee composed of a subset of the directors, that makes the decisions. CEOs and other senior people always have employment contracts which guarantee their base pay levels, but comp committees generally have some discretion as to the awards given for good performance. In other words, if the management team do a really good job, the board can give them extra. And crucially to the current debate, that's supposed to work the other way around, but rarely does.

But having said that, the arrangement generally works well. The directors are responsible to the common stockholders, and in fact are their representatives. There's no a priori conflict in this relationship, and no fundamental reason for wanting to change it.

The first chink in the argument comes from the White House. Since long before moving to the White House, Obama and his economic advisers have been in favor of allowing common shareholders to vote directly on the pay packages of senior executives. Such votes would be taken at annual-meeting time. Think back to the recent annual meeting of Bank of America in Charlotte, when plenty of shareholders would have gladly voted to string CEO Ken Lewis up, on top of cutting the amount of money they paid him.

But what's the point of this? To give shareholders a chance to vent their frustration? What good does that do? The large institutions that own most of America's public stock (the university endowments, pension funds, insurance companies, hedge funds and mutual funds) are fully free to dump stock in companies with poorly-performing managers. Giving shareholders a chance to nick a CEO's pay envelope is only of use to an investor who's too stupid or too static to just sell his shares and buy something else.

It's also completely ineffective. As soon as it becomes possible for shareholders to advise directors to cut executive pay, the executives will start demanding ironclad guarantees of their base pay in their contracts. Satisfying as it might be, the shareholder action becomes an empty gesture.

Now, some people in Congress, notably Barney Frank, are calling for something stronger. They want to make it possible for shareholders of public companies to take binding votes, rather than advisory ones, to reduce executive pay in response to poor performance. Again, it's hard to see the economic rationale of something like this. Is Barney Frank saying that the employment contract of a senior executive should be subject to unilateral revision by one party? How then could such an arrangement even be called a contract?

Or is he saying simply that he wants to enable shareholders to take a small dose of revenge, limiting poorly-performing executives to their base pay and no more? Why can't boards of directors do that today? There's no value added here other than political atmospherics.

But now there's yet a third model, represented by the White House "Czar of the Week," Kenneth Feinberg. In theory, Feinberg, the "Pay Czar" will have unspecified but broad powers to dictate the compensation arrangements of executives in companies receiving government assistance. (I suppose for a start that means the automakers and the TARP-recipient banks.)

In this model, executive pay will become a direct concern of the White House. They would decide how much people should get paid. Someone needs to explain to me just exactly how this can be accomplished across a broad economy without creating either an unworkable, one-size-fits-all pattern, or endless corruption. And even beyond that, there's the chilling uncertainty created, as the rules could change at any time. Why would you bust your hump to do your best work, knowing that if the political winds go against you, you won't get paid your full salary?

In the final analysis, all of this bloviating over executive pay is nothing more than government interference in private contracts. (There indeed are some substantive issues in regard to pay, particularly relating to the financial industry, that I'll have to deal with another day.) But shareholders today have the right to invest in whatever companies they think are run best. And don't think the biggest hedge fund operators or university investment officers have to wait for an annual meeting to make their dissatisfaction felt. CEOs answer to their directors, and directors answer to shareholders. There's more than enough accountability in the process to protect the shareholders.

But there, in fact, is where the camel has stuck his nose under the tent. I don't hear Obama, Barney Frank, Kenneth Feinberg or anyone else talking about protecting shareholders. This isn't a garden-variety overinterpretation of the Securities and Investment Company Acts. What they're saying is that America as a whole needs to be protected from marauding, pillaging CEOs. Today, the argument is that companies receiving TARP money should face government scrutiny for executive pay levels because, after all, We The Taxpayers put in the capital that keeps them going. (And what exactly is our interest as taxpayers, other than revenge, to cut down the pay of executives? Presumably to keep from overpaying them with bailout funds.)

Tomorrow, the argument will extend to executives in all public companies. Already this is where Congressional Democrats are saying they want this to go. But who are we protecting? The common shareholders who are members of the public? I've already explained that they already have enough remedies for dealing with poor executives.

No, the real objective is to "protect" society at large. Given that, how difficult will it be to step beyond publicly-owned corporations and start dictating pay guidelines for everyone? For that matter, we've put tens of billions of dollars into preserving jobs and retirement benefits for the UAW. The taxpayers weren't a party to those private arrangements. Isn't it reasonable for us to insist that the government cut all UAW salaries, pensions, and healthcare payments in half? Just sayin.' Isn't the goal to keep the public from suffering financial harm by overpaying people on public assistance? Or is there personal animus against executives at work here?

I speak as a person who has argued often that CEO compensation is not only excessive in an absolute sense, but also very poorly reflective of actual performance. I think the vast majority of CEOs get paid way too much. But it still needs to be up to people, freely contracting with each other, to determine what to pay each other. If the President of the United States decides that it's his job to determine what any given individual's labor is worth, for whatever reason and under whatever legal theory, then no private contract is safe, and we'll be well along the path to exchanging our free society for a government-run one.

By Francis Cianfrocca
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