Regulating Wall Street Bonuses

The U.S. Securities and Exchange Commission has just announced its intention to exercise oversight over levels of pay on Wall Street. Is this an example of overreaching regulation, or of justified intervention in the public interest?

Here are the details, from Ben Protess and Susanne Craig, on the NYT‘s DealBook blog: S.E.C. Proposes Crackdown on Wall Street Bonuses:

Lavish Wall Street bonuses, long the scorn of lawmakers and shareholders, have met a new foe: the Securities and Exchange Commission.

The agency on Wednesday proposed a crackdown on hefty compensation awarded at big banks, brokerage firms and hedge funds — a move intended to rein in pay packages that encouraged excessive risk-taking before the financial crisis.

The proposal would for the first time require Wall Street firms to file detailed accounts of their bonuses with the S.E.C., which could then ban any awards it deemed excessive. The rules would be aimed at top executives and hundreds of rank-and-file employees who receive incentive-based pay….

In general, we should probably have as our starting point a healthy skepticism about government attempts to regulate pay in particular industries. Remuneration for high-level jobs is typically based on some combination of rewarding past performance and incentivizing future performance, in addition to sensitivity to things like skill, experience, and the scarcity of the particular talents the job requires. And it’s highly unlikely, again speaking in generalities, that government agencies are going to have the right information and motives to allow them to determine with any degree of precision and efficiency just what a private company’s pay structure should be. Now of course governments aren’t the only ones who could err in setting up compensation schemes; private companies are perfectly capable of screwing that up pretty badly themselves. But for the most part, if private companies screw up in that regard, it’s their shareholders that should hold them accountable, just as it is shareholders who ought to hold them accountable for any other foolish spending.

But there are likely to be justified exceptions to the general presumption in favour of the government taking hands-off approach to compensation. If it is the case — and this seems to be the S.E.C.’s conclusion, here — that compensation schemes in a particular industry are seriously and chronically causing harm beyond the walls of the organization, that seems to be a pretty good argument in favour of government action. This is especially true when the damage being done is not “merely” damage to particular individuals or groups, but to the stability of the economy as a whole. And as Protess and Craig point out, “The move by regulators to have more say on Wall Street pay highlights the huge role financial institutions play in the economy.” That is what arguably makes the harm done by Wall Street compensation not just a matter of private wrongs, but of public ones.

But of course, this argument doesn’t mean the S.E.C. should rush in like a bull in a china shop. All of the concerns mentioned above still apply — there are reasons why Wall Street firms have the compensation policies they have, and it’s pretty likely that at least some of those reasons are pretty good ones related to the necessities of the industry. Indeed, the S.E.C.’s chairwoman, Mary L. Schapiro, says that “This is an area where we want to be very attuned to unintended consequences.” The S.E.C.’s objectives here, seem to be good ones; the question will be whether the quality of the agency’s methods live up to the nobility of its goals.

5 comments so far

  1. Randy Grein on

    Great post, as usual. I would like to point out, however that remuneration for corporate executives has increased exponentially in the past 30 years in the US, completely out of line with the rest of the world. A possible explanation is the lack of a free market – the small pool of buyers and sellers gives at least some a real influence on the market price. More likely is the troubling fact that corporate boards are made up mostly by officers of other large corporations; their opinions of their own worth is likely to influence their perception of the value of other executives. I find more business decisions are rationalized than rational, and that includes superstar pay levels for executives.

    In any case, care should be exercised. Correcting the current inequalities at a stroke would likely collapse the entire economy. Much as I would like to do so it’s not safe to do so, and the only safe correction would be to stick to a long term plan that would slowly bring salaries down over a similar timescale that they increased in. Of course, that assumes regulators can determine what the ‘correct’ level would be and have the will to follow through over many years.

  2. jilly on

    I surprise myself, on thinking about this question by finding that I don’t think this type of compensation is the issue, or at least, not the most serious one. I think the dismantling of the regulatory structure over the past several decades is the first thing that should be considered: it should be reversed, now, however difficult that might be. The second thing that needs to be changed is the willingness of the SEC and others to bring charges and lay real penalties against those at all levels of the system who break the rules. Penalties should include fines, loss of license and jail time. It is not enough to try the egregious cases. Regulation and especially enforcement must be everyday, automatic things.

    it is, in my view, much easier to impose the kinds of regulation suggested by the article than either a) deal with the real issues of redressing the long-term restructuring of the financial markets that has led to disaster on an increasingly shortened time-line over the last three decades; or b) oversee the financial industry in a way that ensures that those who break the rules are caught, at the very least prevented from profiting from their actions, and taken out of a position in which they could cheat again in future. There is no will to do that even in the short term. To quote Randy Grein, it would indeed require “follow through over many years.”

    Conclusion: This is an exercise in smoke and mirrors, sort of like prosecuting the lower-level thugs at Abu Ghraib, and leaving unpunished . . . .


  3. John M on

    Characterizing compensation of the great Wall Street institutions as “pay” is pretty funny, and suggesting that the S.E.C. might somehow regulate this is perhaps Utopian, whether or not there’s an ethical case to try. However, I don’t think this is the big ethical question involving regulation of these institutions.

    In 2005 Susan Bies proposed that their day to day regulation fall under the FRB instead of the NY Fed, because the latter is owned by the banks in question as shareholders. Tim Geithner, then President of the NY Fed, managed to block this proposal. I don’t think there’s an ethical question anywhere more pressing than that the world’s most important financial institutions lack independent outside scrutiny.

  4. fibocycle on

    this is a bit off topic–since I am referring to Detroit not the Wall Street gang but…
    The two top Ford Motor Corp. executives received approximately $100 million in stock bonus last year with Mulally receiving $56.5mm of that.
    I realize that some people see no ethical issue here but a major tenet of morality is fairness.
    From an economic perspective, the marginal utility derived from a bonus of $56mm is rather dwarfed by the marginal utility gain by employees if they were to receive shares along with the executives–to say nothing of the incredibly beneficial boost in morale of employees if those shares were given to the employees who were very instrumental in the survival of Ford as an viable automobile manufacturer. Although this $100mm/300,000 employees breaks down to a seemingly paltry $333 worth of Ford stock (approx 20 shares per employee) the benefits to the company would counter-act the feelings of under-appreciation felt by the employees. A employee profit sharing plan would be an excellent way to instill pride and loyalty to the company.Loyalty of over compensated executives only extend as far as the next lucrative offer.

  5. […] the category of “profit” to include individual profit in the form of salaries, then Wall Street is regularly singled out as a place where excessive profits are to be had. The fundamental ethical […]

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