Hoopla Over Pay

The closest I've been to $42.9 million (the total pay received by Goldman Sachs' Lloyd Blankfein in 2008) is in newspaper print. But I'm not appalled, aggrieved, or angered—or any emotion those on Capitol Hill seem to suggest I should feel about financial CEOs' "excessive" salaries.

Rather, I'm bewildered. I've always thought making loads of dough was the American dream—or at least the means to achieve the American dream of house, vacation house, houseboat, and at least three cars. Turns out, making dough actually leads to trouble—at least according to pay-bashing politicians.

Believing a root cause of last year's financial crisis was excessive risk-taking tied to "excessive" pay, politicians are seeking ways to curb both. In a 237-185 vote last Friday, the House of Representatives approved a bill to increase scrutiny and give shareholders greater say on executive compensation at large financial firms. The bill heads to the Senate next, and its future there is far from certain (Senate Democrats have yet to endorse it).

Their aims are grand, I'm sure, but unfortunately don't reflect economic and market reality. Don't get me wrong—I'm boggled by the idea of salaries equivalent to small countries' GDP (ironically, a large portion no doubt goes to Uncle Sam), and maybe certain compensation structures at financial firms were a skewed toward taking heavy bets (though arguably, it's the nature of their business). I just don't think there's any way the government or anyone else can prevent another financial meltdown by imposing regulation on pay. Instead, it's likely this measure (or similar measures) will simply lead to market distortions and unintended consequences (see general US history for more).

There's a reason why the US has so many corporate tax loopholes. When the government intervenes in business, businesses try to find ways around the interventions. They aren't shady; they're being competitive. Why? Free markets produce the most efficient and profitable allocation of resources. Wages are a key factor to achieving that efficiency.

How do companies find employees that match their needs? In a free market, a company finds the right employee through compensation signals. Companies aim to generate and increase profit. To incentivize employees to want the same, companies award them with pay—usually commensurate with education, qualifications, performance, etc. Look to the nearest apathetic teenager working the food court to realize not all companies are willing to shell out for a PhD go-getter—some companies simply want someone who can do the job at the offered wage. For companies valuing the bottom line, "you get what you pay for" isn't necessarily bad.

Regulating pay, however, skews those signals. Either companies will try to find loopholes in the imposed restrictions (often leading to other unintended, undesired consequences) or employees will simply choose not to work there. Neither is desirable—especially considering the financial industry will need smart, qualified, and driven individuals to regain its footing.

Perhaps there's a point to be made about certain compensation practices at financial firms. But surely these firms, many of which suffered tremendous losses in firm assets and in personal wealth, will be taking a good, hard look at their own practices? Little good has come from overly reactionary federal business regulations, though a lot of good has been generated by businesses fixing their own mistakes and evolving on their own. And in my view, the stock value of a publicly held company is a better judge than any government bureaucrat in determining the success or failure of reform efforts.

The signal politicians are sending out today against big bucks is worrisome. Profit incentives have led to some of the greatest innovations in US history—and improved our standards of living along the way. It's not just coincidence some of the richest individuals in history have also contributed a ton to society (John D. Rockefeller, Andrew Carnegie, Henry Ford, Bill Gates, Sam Walton—to name a few). If no one aimed for profits, no one dared collect a penny for their work, where would that lead our economy?

I'm not saying we should trumpet over-the-top pay, but at the same time there's no need to decry them with laws reeking more of scapegoating than sound economic and market judgment.