There's mounting talk on Capitol

Hill that a Wall Street bailout will include some limits on executive

compensation, as well as contradictory reports about whether a deal on

controlling executive pay has already been reached.









Four days ago, such a move seemed very unlikely. But the pushback from

Congress -- from both Democrats and Republicans -- has been

surprisingly robust, thanks in considerable part to a surge of outrage

from the public.









Will restrictions on CEO pay just be a symbolic retribution, as some have charged?









The answer is, it depends.









Meaningful limits not just on CEO pay, but also on the Wall Street

bonus culture, could significantly affect the way the financial sector

does business. Some CEO pay proposals, by contrast, would extract a

pound of flesh from some executives but have little impact on incentive

structures.



There are at least five reasons why it is important to address executive compensation as part of the bailout legislation.





First, there should be some penalty for executives who led their

companies -- and the global financial system -- to the brink of ruin.

You shouldn't be rewarded for failure. And while reducing pay packages

to seven digits may feel really nasty given Wall Street's culture of

preposterous excess, in the real world, a couple million bucks is still

a lot of money to make in a year.









Second, if the public is going to subsidize Wall Street to the tune of

hundreds of billions of dollars, the point is to keep the financial

system going -- not to keep Wall Street going the way it was. Funneling

public funds for exorbitant executive compensation would be a criminal

appropriation of public funds.









Third, the Wall Street salary structure has helped set the standard for

CEO pay across the economy, and helped establish a culture where

executives consider outlandish pay packages the norm. This culture, in

turn, has contributed to staggering wealth and income inequality, at

great cost to the nation. We need, it might be said, an end to the

culture of hyper-wealth.









Fourth, as Dean Baker of the Center for Economic and Policy Research

says, the bailout package must be, to some extent, "punitive." If the

financial firms and their executives do not have to give something up

for the bailout, then there's no disincentive to engage in unreasonably

risky behavior in the future. This is what is meant by "moral hazard."









If Wall Street says the financial system is on the brink of collapse,

and the government must step in with what may be the biggest taxpayer

bailout in history, says Baker, then Wall Street leaders have to show

they mean it. If they are not willing to cut their pay for a few years

to a couple of million dollars an annum, how serious do they really

think the problem is?









Finally, and most importantly, financial sector compensation systems

need to be changed so they don't incentivize risky, short-term behavior.









There are two ways to think about how the financial sector let itself

develop such a huge exposure to a transparently bubble housing market.

One is that the financial wizards actually believed all the hype they

were spreading. They believed new financial instruments eliminated

risk, or spread it so effectively that downside risks were minimal; and

they believed the idea that something had fundamentally changed in the

housing market, and skyrocketing home prices would never return to

earth.









Another way to think about it is: Wall Street players knew they were

speculating in a bubble economy. But the riches to be made while the

bubble was growing were extraordinary. No one could know for sure when

the bubble would pop. And Wall Street bonuses are paid on a yearly

basis. If your firm does well, and you did well for the firm, you get

an extravagant bonus. This is not an extra few thousand dollars to buy

fancy Christmas gifts. Wall Street bonuses

can be 10 or 20 times base salary, and commonly represent as much as

four fifths of employees' pay. In this context, it makes sense to take huge risks. The payoffs from benefiting from a bubble are dramatic, and there's no reward for staying out.









Both of these explanations may be true to some degree, but the

compensation incentives explanation is almost certainly a significant

part of the story.









Different ideas about how to limit executive pay would address the

multiple rationales for compensation reforms to varying degrees.









A two-year cap on executive salaries would help achieve the first four

objectives, but by itself wouldn't get to the crucial issue of

incentives.









One idea in particular to be wary of is "say on pay" proposals,

which would afford shareholders the right to a non-binding vote on CEO

pay compensation packages. These proposals would go some way to address

the disconnect between executive and shareholder interests, reducing

the ability of top executives to rely on crony boards of directors and

conflicted compensation consultants to implement outrageous pay

packages. But while they might increase executive accountability to

shareholders, they wouldn't direct executives away from market-driven

short-term decision making. Shareholders tend to be forgiving of

outlandish salaries so long as they are making money, too, and -- worse

-- they actually tend to have more of a short-term mentality than the

executives. So "say on pay" is not a good way to address the multiple

executive compensation-related goals that should be met in the bailout

legislation.









The ideal provisions on executive compensation would set tough limits

on top pay, but would also insist on long-term changes in the bonus

culture for executives and traders. Not only should bonuses be more

modest, they should be linked to long-term, not year-long, performance.

That would completely change the incentive to knowingly participate in

a financial bubble (or, more generously, take on excessive risk),

because you would know that the eventual popping of the bubble would

wipe out your bonus.









Four days ago, forcing Wall Street to change its incentive structure

seemed pie in the sky. Today, thanks to the public uproar, it seems

eminently achievable -- if Members of Congress seize the opportunity.

http://www.multinationalmonitor.org/editorsblog/index.php?/archives/98-Getting-Wall-Street-Pay-Reform-Right.html

Robert Weissman is managing director of the Multinational Monitor.





AMP Section Name: Financial Services, Insurance and Banking