Epstein: "Executive Compensation Follies"

Executive Compensation Follies
Richard A. Epstein
October 28, 2009

The topic of executive compensation has once again hit the front pages, and with more heat than light. Adding fuel to the fire is the return of profitability of major banks, whose lavish pay scales at the top make ordinary people (and not a few professors) drool with envy. So we face this challenge. How exactly can regulators constrain pay without wrecking the entire financial sector?

I suspect that no collective mandate can do the job, either by controlling the mix of present and deferred benefits, or by imposing hard wage caps. Economist turned populist Ben Bernanke has a better idea. He thinks he can remove one set of imperfections from the executive compensation market without creating a second set. I have already expressed my doubt on this score. Alas, it is time to do it again.

Start with Bernanke's critique: "Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability." Then comes the punch line: "The Federal Reserve is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system."

Richard A. Epstein