Paying the most talented

Steve Chapman of the Chicago Tribune had a post on his blog a couple of days ago that well summarized the thinking of those who find a cap on executive salaries distasteful. (I understand that there are already considered opinions that say that business "leaders" will be able to find ways around that, and I'm sure that's true. For the moment, let's take the cap at face value.)

Chapman:

President Obama slapped banks getting federal money with new limits on executive compensation, which will max out at $500,000 a year. This figure is below what most CEOs get, which suggests that these institutions will have trouble recruiting or retaining the best managers. That would be hard enough without the pay cap, since the job description--pulling a bank out of near-bankruptcy in the midst of a serious recession--is enough to make a lot of prospective CEOs contemplate the pleasures of retirement, something most of them can afford.

A common reaction is to say that we can do without the most talented executives in the financial sector, given their disastrous performance. But it's never wise to assume that someone else can't do an even worse job. The New York Yankees, who have the biggest payroll in baseball, haven't won a World Series lately. Any team in baseball would still agree that spending more improves your chances of winning.

Hardly anyone believes politicians are competent to set salaries in any other private sector industry. The fact that some banks are getting federal aid may be an excuse and a means to tell them what their executives should earn, but it doesn't render the government any more capable of handling a task that can only be handled by the interplay of supply and demand.

This is quite the mix of right and wrong. I certainly share Chapman's concerns about the involvement of the federal government in the hands-on running of public companies, even though it is fair to question whether the banks and auto makers getting government help are truly market-based any longer.

Chapman fancies himself a libertarian, so he strongly tends toward acceptance of market solutions to any problems, which requires one to believe that industry is invariably more efficient than government, something that has been pretty well disproven by now. We're actually left in a real dilemma, where we have to decide if we'd rather have John Thain or a GS-14 running our financial institutions.

Where Chapman falls off the track, however, is when he throws around terms like "best" and "most talented." If we measure by results or prescience, the current crop of financial managers are neither of those things. We have bank CEOs who rode a clear bubble in real estate to great personal riches and outsized company returns. It is quite obvious that accomplishing those things wasn't all that difficult; it would have been far more impressive if one of them had broken away from the herd and positioned their company for what was inevitable.

Chapman makes a false analogy in comparing this situation to that in baseball. The goal in baseball is not to make the most money, but to win championships. In business, there are no championships - the goal is to achieve profits, which you do partly by controlling costs. Yes, to a certain extent, you spend money to make money, but one of the great challenges is walking that line. Steinbrenner has never looked at his Yankees the same way.

This column also features the common belief that executive salaries are the natural result of supply and demand. Is there anyone left who believes that CEOs get and retain their jobs strictly on that basis? There are many features of the marketplace for "executive talent" that do not fit the assumptions of the free market. (Look at this post from November where I cite Mark Thoma on how markets fail to match up to theoretical models.)

If we had seen executives act responsibly (when the going gets tough, the tough redecorate their offices), we might be able to trust them a little more. But they haven't.

And Chapman also forgets that this cap is not permanent. If one or more of these clowns figure out how to "pull a bank out of near-bankruptcy," the compensation will come...maybe not this year or next, but soon enough.