The New York Times is reporting that the Obama administration is going to impose a $500,000 cap on executive compensation for companies that receive "large amounts" of federal bailout funds. According to the Times, the details of the plan will be announced at 11am Wednesday morning.
Large bonuses following large bailouts create an understandable (and large) amount of anger. But there is good reason to doubt that capping executive compensation is the right answer. I count six reasons why this might not work as planned:
1. Water runs downhill. Fifteen years ago, when Congress said that only first $1 million of an executive's salary would be tax deductible, companies started paying their top executives in other ways, like stock options and deferred compensation. Other attempts to limit executive compensation have sprouted similar leaks.
2. The ghost of Hank Paulson. Bush's last Treasury Secretary used to say that adding compensation caps would make a bailout program "seem punitive" and give ailing companies a reason not to take part.
3. Agency problems. Related to number two: Might an executive risk the health of his or her company rather than accept lower compensation? (Dick Fuld, anyone?)
4. Labor-market distortions. There is not an infinite number of talented executives, and the market for those employees is competitive. If you cap the salaries in one particular industry then the most talented employees in that market will have less incentive to seek the jobs for which they are best qualified.
5. The health of the companies. Related to number four, if capping compensation for firms that accept bailout funds causes executives to look elsewhere for work, then companies that gain bailout funds might lose their most talented executives, and companies in need of restructuring might have difficulty competing for the most talented employees.
6. Fairness. The Times reports that "companies that have already received money from Treasury Department would not have to make any changes" to their compensation plans. But why should companies that accept bailout money at one point in time be treated differently than companies accept funds several months later?
For what it's worth, numbers four and five seem the most serious. And it's always worth thinking about the alternative: if high compensation is bothersome, why not raise the top marginal tax rate? (Or is it that we want to stick it to bankers and auto executives in particular?)