[ExI] Restructuring executive compensation

[Dan]

--- On Sat, 5/30/09, Max More <max at maxmore.com> wrote:
> While I think there is value in the
> high-level discussions of what caused the financial mess and
> ensuing economic contraction, not enough attention on this
> list has been given to the specifics. While I agree with
> those who point the finger at government policies (including
> those of the Fed and Freddie Mac, Fanny Mae, etc), I also
> agree that the market economy does experience swings. These
> are not necessarily bad, but smoothing them out a bit is
> probably good -- making economic coordination easier and
> reducing the costs of misallocated resources.

I'm not sure those swings are endogenous to the market economy.  In fact, there's reason to suspect on a totally free market, there would be few if any total economy swings, but only localized or at best secoral ones.  Of course, all of this would depend on the choices people make, but the kind of systematic behavior we now see -- e.g., where many US investors invested in emerging markets during the 1990s because, it seems, the Fed or US federal government would bail them out (as it did with the Peso crisis, the Asian crisis, and the Russian crisis) -- seems due to interventions.  Interventions on the whole tend to make any economy less flexible; interventions in finance and money more so than others because banking and money impact the whole economy.
 
> One factor that no doubt contributed to the problems is the
> way executive compensation has been incentivizing executives
> to take on excessive risk in pursuit of short-term gains.
> That is *not* inherent in the market system; it's a result
> of the specific compensation schemes used.

I'm not as well versed in this area as I'd like to be, but from my studies the question to ask is why are certain "compensation schemes" selected?  This has not been an area of zero intervention and seems related not merely to direct interventions in compensation (e.g., caps on payouts, including the 1993 one you mention*) but also to the threat of interventions (as when news stories get published and the Congress holds hearings; threatened regulation is an intervention in the same way as a mugger threatening to kill someone changes the victim's behavior -- even if the mugger never actually lays a hand on the victim**) and other regulations in the market.

On the latter, think of the regulation of corporate takeover.  Takeovers were lambasted in the press until laws were passed (from the Williams Act in 1968 on down) requiring all sorts of delays and approvals for a takeover to get a green light from the regulators.  But such takeovers generally happened because takeover targets were thought to be poorly run, often with managers overpaid.

> Four authors have
> recently published a working paper suggesting a better
> compensation scheme. My review is here:
> 
> "Dynamic Incentive Accounts"
> http://www.manyworlds.com/exploreCO.aspx?coid=CO5290911481773


I would only want to see this plan voluntarily adopted -- and not adopted merely because of either a legal mandate or the threat of such a mandate.

Regards,

Dan

*  Actually, this shifted compensation more toward options, making managers more likely to take big risks.  Why not just remove this cap and others like it?

**  Jesse Walker pointed to this in how the Hayes Code came about -- studios adopted the code because they feared the government would come in and regulate them:

http://www.reason.com/news/show/27954.html