September 2012 Bar Bulletin
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September 2012 Bar Bulletin

Shareholders Need to Rein in Executive Pay

By Christopher Pitts

 

Executive and financier compensation is criticized as unfair, inefficient and a significant contributing factor to the economic crisis. The public conversation is often fractured, over simplified and highly partisan. What follows is an endeavor to outline the current debate while hopefully providing a helpful nudge in the right direction.

It is helpful to start by contemplating how odd it is that executives and bankers make as much as they do. Unlike medicine and law, there are no real educational or guild-like barriers to entry, the pay is high and there is no shortage of qualified applicants willing to do the work. Indeed, one of the theoretical pillars of private equity investing is that executives are, for the most part, overpaid fools.

Simple supply and demand suggest that bankers and executives should make far less than they actually do. Where supply and demand are not operating efficiently, it suggests market distortion (and an opportunity for men like Carl Icahn). Put differently, were it possible to run companies and allocate capital well and at less expense, society would presumably be better off.

As to the cause of this distortion, the usual suspects are as follows.

Size

Executives are paid more because company size has grown. Increases in banking activity (trading volume, advisory, etc.) are similarly credited for the rise in banker pay. Since 1980, companies and executive pay have grown in lock step by about 500%.1

The problem with this theory is that U.S. companies and investment banks also grew significantly from 1945–1969 without a direct, correlating increase in pay. Size alone is not a sufficient explanation for recent increases in pay.

Short-Term Incentives


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