Pay Controls Do Not Work at Any Level-Becker

Several big banks and other companies have badly fumbled their public relations during these difficult times, such as the big three auto makers who took their private jets to Washington to beg Congress for a bailout, or the board and CEO of Merrill Lynch that granted generous bonuses to their executives just as the company was avoiding bankruptcy through being taken over by Bank of America. However, anger, even when justified, is not a good reason for ceilings on the pay of top executives at companies receiving assistance from the federal government. The main problem with wage (and price) controls is that they never work, although governments have imposed them throughout history. They will not work in this case either, where the plan includes a salary cap of $500,000 for top executives at companies taking "extraordinary assistance" from the federal government, restrictions on when these executives can cash in the stock they will receive, limits to their severance pay, and monitoring of fringe benefits, like company jets. There are no good guides to a priori setting of either the form or the level of compensation to employees in any occupation, including top executives. Competition, with all its defects (which I discuss later), is still the best mechanism available for setting salaries and other prices. Pay caps will encourage companies that take government aid to hire high priced lawyers and accountants to devote their expensive time trying to find loopholes in these caps. Loopholes include reclassifying some employees to positions below top executives so that their pay would not be subject to any government pay caps. Most loopholes center on various forms of deferred payments and non-monetary benefits. For example, companies started to provide free medical coverage to its employees during World War II as a way to circumvent controls over wages. This fringe benefit has persisted as a tax advantage that is usually not available to workers who pay for their own medical insurance. The plan for executive pay caps already includes restrictions on several fringes, including the ownership of corporate jets by companies taking government assistance, even though company jets are often valuable savers of the expensive time of executives who do a lot of traveling. Able lawyers and accountants will discover many other fringe benefits that can help circumvent the pay caps. Companies that take government assistance do so because they fear going bankrupt. Sometimes that is because they were badly managed by the CEOs and other executives in charge. What many of these companies need are new executives who can take a fresh look at their problems. Unfortunately, pay caps that leave total pay considerably below what able executives receive in other companies make it more difficult to attract these executives to companies in distress because they can earn more, and work with considerably less government interference, in companies that do not take or need aid. Moreover, severe limits on severance pay help to lock in incompetent executives who then might refuse to leave voluntarily because they would not receive any significant financial incentives to leave. Apropos of turnover of top executives, I believe many company boards, and also boards of universities and other non-profit institutions, fail in their most important responsibility: to determine when top management should be replaced. This is partly because many board members spend very little time on board activities, and also because many members are friendly, or at least sympathetic, to the top executives. As a result, they are either too ignorant of how the companies they oversee are really doing to overrule top management, or they are too close to management to make the hard decision to fire them when they perform badly. Of course, one reason caps on the pay of bank top executives are popular is because of the general perception that boards of directors also overpaid these executives, and thereby failed in this duty to protect stockholders. Perhaps they did, but even if the pay of top executives at many banks and funds were well above what they would receive in a well functioning competitive market for executives, that could not explain the devastating hit taken by stockholders of these companies during this crisis. For example, even a 100% overpayment to bank executives would usually have only a small direct effect on bank profits since their pay, however large in an absolute sense, was rather small compared to the normal profits of these companies. Another criticism of the compensation of the top executives of banks and other financial institutions is that it encouraged excessive risk-taking because their pay was excessively loaded toward stocks and bonuses. In retrospect, obviously, top executives of many financial companies took risks that turned out to be catastrophic for stockholders and employees. Yet, since the value of the stocks owned by these top executives also dropped sharply, and since their bonuses have been sharply reduced or eliminated, most top executives did suffer greatly along with stockholders when their risky decisions failed. So any distortion in the pay structure toward risk taking was surely limited.

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Taxing the rich or big companies often doesn't work either as many find ways to evade taxes. According to Becker this should be an argument to abolish taxes for anyone but the poor.

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