Three Cheers for Obama's Pay Cap

Company owners get to set salaries.

As President Obama's election victory demonstrated, the American people are in a surly mood.  Almost all of us are worried about our jobs, our country, and our future.

There is a strong sense that we've been robbed; the left likes to blame George W. Bush, of course, but most folks would probably point at the corporate titans who have destroyed not just their own companies but the investment savings of countless common people.  Yet, while Grandma asks to move in with the kids because her retirement savings have been decimated at the same time as her kids ask to move in with her because they just got laid off, business leaders still rake in more money in one year than most people will see in their entire lives.

In normal times, the government has next to no authority to control executive pay.  These are anything but normal times.  CNN reports:

President Obama is having his say on soaring executive pay.  New rules unveiled Wednesday morning will cap annual cash compensation for executives at firms receiving future government aid at $500,000.  The guidelines prohibit payments above the $500,000 threshold in anything but company shares that must be held until the government's investment has been repaid. [emphasis added]

At first blush, this may seem like a very bad trend.  How is it that any government entity, much less the President, should dare to sat a maximum amount that a private individual may earn, or that a private business may pay?  Why shouldn't the government impose these caps on famously leftist groups, too, like sports "heroes" and other entertainment stars?

There's an essential principle here that's easily overlooked.  Obama's latest move, regardless of what he meant or why he did it, is not a dagger in the back of capitalism.

Far from it - it is a strong blow for capitalism, properly understood.

The Owners Are The True Masters

As much as they would like you to believe otherwise, corporate titans of companies whose stock is publicly traded do not own the companies.  They are not the owners, not the emperors, not the Masters of the Universe as they try to act.

At the most fundamental level, they are employees - paid by the true owners to provide a service, that of management.

Just who are the true owners of a company?  The stockholders.

Right now, thanks to the crash having wiped out the rest of the stockholders and the bailout funds giving government an ownership position, the companies bailed out are largely owned by the United States government.

Logically, what difference does it make to corporate pay whether a company's largest stockholder is Warren Buffet, a pension fund, an Arab oil sheik, or the U.S. Treasury?  No matter who the owner might actually be, the corporate executives work for that owner.

Of course the owner has the right to set a limit on how much management salary they're willing to pay; how could it be otherwise?

In effect, President Barack Hussein Obama now owns as subsidiaries such famous names as Citigroup, Wells Fargo, AIG, and on down the line.  Not only does he have the right to limit executive salaries, it's part of his job - just as any other executive is responsible for deciding how much his workers should get paid.

Some of the banks signed up for bailout money before Obama announced this restriction; here's hoping he's able to impose the limit on them anyway.

One of the most scandalous aspects to the housing bubble was the grossly overpaid incompetents at Fannie Mae and Freddie Mac.  These executives, mostly Democrat pols or insiders, raked in millions in salaries and bonuses because their companies had an unfair advantage: the implied government guarantee.

When they went bust, that guarantee was called in, and taxpayers are now on the hook for billions - but the architects of the disaster have retired to the Hamptons, their paychecks securely stashed in Swiss banks.  The left complains about the privatization of gains and the socialization of losses.  In the case of Fannie and Freddie, this complaint is totally accurate.

With the government basically owning all manner of giant banks now, the exact same problem would inevitably happen again.  How could it not?  If you can freely tap into Uncle Sam's pocket, why wouldn't you skim some off for yourself?

Obama's action puts paid to this looting.  If he is able to properly enforce this edict, not only against any new bailout-ees but against existing ones, he'll save the taxpayers who now own the banks millions.

Are The Best Worth Megabucks?  Let's Find Out

There's one more reason why Obama's pay cap is a fantastic idea, fully in keeping with the best of capitalism.  Lavish executive salaries have been the subject of concern for years, and what argument do their defenders always use?  "You have to pay top dollar to get the very best leaders - and a huge company needs a super leader to make money for its shareholders."

Is this argument valid?  Or were executive salaries artificially "bid up" by cronyism, featherbedding, and insider trading?  We're about to find out, because Obama is setting what amounts to a new standard.

These new government protectorates will have executives that are paid very little in comparison to their peers at banks which managed to avoid being bailed out.  At least as far as we can tell, the bailed-out banks won't have any other advantages - for example, Obama hasn't announced the creation of government monopolies.

So in the same market space there will be both government-owned companies run by executives with low salary caps, and also completely free and independent companies run by executives who are paid whatever the board of directors agrees to.

If, truly, the very best leaders require astronomical salaries, then the banks with salary caps won't be able to afford any managers but losers.  Every last one of the best leaders will go to the private firms, which will then proceed to run rings around the others thus hobbled.

In time, the government-owned failures will go out of business; the government will be out of the business world as it ought to be.  Problem solved!

For sure, New York City believes this is what will happen; we're seeing reports of panic in the streets that the executives of New York's bailed-out banks, wanting more than a mere half-mil, will be decamping to greener pastures.

If, on the other hand, mega-salaries are not truly required, but came about by insider games, we'll all be able to see it.  The government companies with their cheap leaders will be able to compete just fine.

Once that fact becomes widely recognized, what owner or board of directors would be able to justify a multi-millionaire salary for an executive when their government competitor is doing just as well paying a paltry few hundred grand?  The executive salary ratchet will go into reverse all by itself, without the need of further government intervention.

This won't be good news for anyone who hoped someday to reign atop a giant firm.  For anyone who might invest in one - which is to say, almost every American - this is fine news.  What's more, it's free enterprise at the behest of government!

Who would have thought that Barack Obama the socialist would turn out to set up such an excellent competitive test of the free market?  By accident or by design, he may just be bringing us Change we can Believe In - a world where top executives are properly paid for excellent performance, and not otherwise.

Now, if only he'll apply the same sort of discipline to teacher's unions...

We won't even mention UAW executives.

Petrarch is a contributing editor for Scragged.  Read other articles by Petrarch or other articles on Economics.
Reader Comments
I believe that this article hits on what is perhaps the greatest problem facing modern capitalism. While I understand (at last most) of the benefits of creating corporations it creates a problem where the people who run the business do not have the same interests as the business it self.

In a sole proprietorship no matter how wealthy the owner if the company goes down in flames and debt the owner is at risk. The owner therefore has a very large incentive to ensure that his company stay profitable and out of debt as much as is possible

In a corporation if the company fails while owing billions of dollars the executives can shrug their shoulders take the millions that they've been paid and move on.

This system removes the risk from the executives for their decisions and encourages them to maximize short term profit. The short term profit decides how they're paid. While I am sure that the executives themselves usually believe they are doing what is best for the company their view is clouded by what is best for them.
February 5, 2009 9:25 AM
As nice as this may seem, it's a bad move. The reason has nothing to do with the aid itself, but with the mentality this fosters with our ever-dimwitted society. You and I can make the distinction between the government regulating companies because of ownership, but most cannot. The more Obama dictates to the private market what they can and cannot do, the more that mentality will grow and be expected even OUTSIDE those that are aided.

You said "the companies bailed out are largely owned by the United States government"

To clarify, that is NOT a majority percentage. Bank of America has gotten the largest amount of aid, currently up to $45 billion, which makes the governments ownership stake only 6%. That is larger than any other single shareholder, but it is by no means a majority or even close to it.

Are you suggesting that a shareholder that only owns 6% of a business should be able to make all the rules of that business?
February 6, 2009 8:16 AM
This is just the beginning. Limitations on executive compensation for non bailed out companies will be next. It's the typical government ploy: "Here, have some money. Oh wait, there's a few string attached... Don't pay attention to the man behind the curtain."

It happened with the highway system and feds enforcing speed limits and other standards nationwide. It happened in spades with the feds taking over the formerly state by state educational system.

Before you say "it can't happen here, it can't happen to us, it's just those other guys", consider this: Obama's newly minted Secretary of the Treasury has already stated his intention to expand these provisions to all companies:

"Mr. Geithner said he would consider "extending at least some of the TARP provisions and features of the $500,000 cap to U.S. companies generally.""

The great Barney Frank "said the compensation restrictions would apply to all financial institutions and might be extended to include all U.S. companies."
February 6, 2009 11:55 PM

Good find. So we're seeing it already. Once you give the government ANY control into the private market, it only worsens.
February 7, 2009 9:18 AM
This latest development proves my point.

It's not really accurate to describe the government's investment in the bailed-out banks in terms of a percentage of ownership. The feds came up with emergency funding when the banks were under extreme stress and were about to fail without it. This sort of emergency capital injection, when done by private parties, amounts to a gun to the head - the investor can pretty much demand whatever condition he pleases.

The government doesn't have ordinary shares, it has a special primary call so as to get paid before anyone else does, and also additional restrictive covenants. In this light, it's much more like a Debtor-In-Possession loan that you'd get during a Chapter 11 bankruptcy, or an emergency bridge loan. So yes, I do view the government as having a moral right to impose conditions on the banks it bailed out - if it wasn't for the bailout money, the banks would be dead and gone and the stockholders would have nothing anyway.

More to the political point, though, the American people are furious enough at the bailouts and the sense that corporate titans are ripping them off. They are barely stomaching their tax dollars being given to banks at all; they will not stomach them being used for "overpriced" salaries and expensive perks. Some sort of limit is politically inevitable.

This being the case, it's far far better to explicitly link the salary caps to the direct government investment, under the guise of "ownership." That establishes a clear wall between the companies government owns and thus has a right to over-regulate, and those it doesn't and shouldn't. If that wall is breached, capitalism is doomed; better at least to attempt to paint the clear line somewhere where there is a logical argument for it, that the American people might possibly understand and accept.
February 8, 2009 6:50 AM
"the investor can pretty much demand whatever condition he pleases"

Not after the fact. Obama's pay cap is on the FUTURE wishlist. The $45 billion, buying 6% ownership, already happened.

Investors can't buy up debt, then turn around later and expect retroactive conditions.

Of course, no ever faulted the government for being a wise investor. Look what they've done with Social Security.
February 8, 2009 9:49 AM
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