Outrage over the large salaries and bonuses paid to executives at financial institutions that had to be bailed out by the government has naturally led to calls for limits on such compensation. Setting those limits, however, is a job better left to shareholders than to the federal government.
A major reason for the public outrage is that multimillion-dollar salaries and bonuses were paid to some executives even as their companies teetered on the brink of failure. Basically, compensation had been separated from performance. Having the government set compensation limits without being responsible for setting performance targets and assessing whether they’ve been met only makes this separation worse.
Despite this problem, the Treasury Department and Federal Reserve announced last week that they would limit the pay of top executives of banks and other financial institutions. Treasury’s caps are limited to the seven companies that still get assistance from the Troubled Asset Relief Program and will run through the end of the year. The limits set by the Federal Reserve are, as of now, vague, but will apply to all the banks it oversees.
The Wall Street Journal called the moves an “unprecedented federal intervention.”
The Treasury Department announcement had long been expected as President Barack Obama had appointed a “pay czar” as part of the government’s multibillion-dollar package to keep several large financial institutions and America’s car companies afloat. Ken Feinberg was given the task of setting compensation levels for executives at the seven companies still using TARP funds. Mr. Feinberg also had the difficult task of determining appropriate payouts to the families of victims of the Sept. 11 terrorist attacks.
The rationale is that because these companies are getting government help, the government should ensure that salaries and bonuses are reasonable. This only makes sense for AIG, the insurance and financial company that is now mostly owned by the federal government, said John Mahon, dean of the University of Maine School of Business. As the largest shareholder, the government can appropriately have a hand in setting pay for the company’s executives.
As for the other companies, Professor Mahon says the government is putting itself in the odd situation of determining how much people should be paid without being responsible for the companies’ success or failure. Worse, setting compensation limits now will punish people who had nothing to do with the schemes that caused the financial sector to collapse. This is especially true of the Federal Reserve’s forthcoming limits, which will apply to banks across the country that never dealt in derivatives or other shaky investments.
Cutting huge salaries makes for good political theater — populist retribution, as the Wall Street Journal put it — but it treads dangerous territory for federal regulators.