The Obama Administration made big news today by announcing that the 25 highest compensated executives at the 7 biggest recipients of funds (Citigroup, AIG, Bank of America, GM, Chrysler, and the financing arms of GM and Chrysler) will see markedly reduced compensation this coming year. The blogosphere is of course up in arms about this; lots of libertarians and conservatives think that this is a horrendously bad decision, and that this will cause executives to flee these companies. I think differently. Here are a couple reasons:
1. Expectations: executives at these companies had to know this was coming once they asked for bailout money. Government money makes business decisions at these companies a political affair and it was unreasonable for executives to not make the calculation that politics would work in their favor. That is to say, the mass exodus everyone is predicting should have happened months ago. That an exodus has not happened is telling. Perhaps it is also true that these executives have nowhere to go; would you hire a GM executive with a resume detailing their role in running their companies to the ground?
2. More expectations: I bet executives at these companies look at the endgame. Ultimately either these companies will unwind their operations or will return to profitability. In 2-5 years it will have been better for executives at companies that expect to return to profitability to have stayed with the company than to have left and tried to find work elsewhere. At some point these companies will unwind themselves from the government lifeline and have freer reign to reset compensation schemes at which point loyal executives should expect to see themselves handsomely compensated.
3. Some of next year’s compensation for these executives will be in the form of stock options, not cash, in what looks like an effort to have executives invested in their company’s performance. An attempt to solve the principal-agent problem? Likely.
4. And finally, it seems to me that part of the message that the Administration is sending is that these executives are expendable. If we can find smart people like Geithner to run big, important organizations like the Treasury Dept. for a salary that’s just under 200K, then it seems obvious that we can find qualified, motivated people to replace executives who do choose to leave. There are a lot of smart people in the world and these executives don’t have a monopoly on the qualities that make good executives. In fact, it’s probably true that some of them just don’t, since it was under their watch that these companies asked for a bailout.
So is the Administration’s decision to cut executive compensation a big deal? I don’t think so. My argument boils down to two claims: first, that there will be no executive flight (it would have already happened), and second, that even if there is executive flight, it doesn’t matter because these people are replaceable.