More on the "Pay Czar" and Compensation Issues

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I mentioned briefly in my most recent blog entry the Obama Administration's recent appointment of a "pay czar" to regulate executive compensation in companies that receive federal bailout money. I expand on my discussion here.

 

There are two distinct compensation issues arising from the current economic crisis. One involves the compensation of executives of firms that are owned or controlled by the federal government, such as General Motors, American International Group, Fannie Mae, and Freddie Mac, as a result of federal bailouts in the form of equity investments rather than loans. The other issue involves recipients of federal bailout money that nevertheless remain under private ownership and control.

 

The former group--firms actually owned or controlled by the government--are (or were, when the government took them over) deeply troubled firms, and there was, and perhaps still is, a danger that management might try to siphon bailout money into dividends and bonuses so that shareholders and executives would be "bailed out" should the company fail completely. If management yields to this temptation, the company's creditors are hurt and the company is weakened.

 

The right time to deal with this problem, however, is when the bailout is made. Suitable conditions can be attached to the bailout. For example, a maximum percentage of the company's cash flow could be specified that could be used for compensation of top management, and the board of directors left free to decide how to allocate that money among the top executives. Cash dividends could be limited or banned altogether. But to instead appoint a "pay czar" to regulate executive salaries of bailout recipients on an ongoing, ad hoc basis (and with dividends left unregulated) is bound to create confusion and uncertainty and may cause a flight of able executives from the firms and difficulty in hiring good replacements.

 

These problems are especially grave with regard to General Motors and Chrysler, as these are fast-failing firms that need to be able to offer high salaries to retain and attract able executives. Between efforts by the "pay czar" to limit these companies' flexibility in compensation, and the efforts by Congress to limit the companies' ability to import vehicles and close plants and dealerships, the government is doing to best to minimize its chances of ever recovering its $60 billion investment in the two firms.

 

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Richard A. Posner

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. More

Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.
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