In the Washington Post, Steven Pearlstein opines over the growth of outrageous executive compensation, despite the weak economy:

The data from this spring’s proxy season is mostly in and it shows that after two years of decline, the average compensation for chief executives of the 500 largest U.S. corporations is on the rise again. According to Governance Metrics International, the average “total realized compensation”…was just under $12 million in 2010, up 18 percent from 2009…

This wasn’t supposed to happen.   The Obama administration tried to reverse this phenomenon. As I said almost two years ago:

The Obama administration is proposing two major reforms. First, shareholders get more power over how much top executives get paid. Second, the company can “claw back” some of those payments after a few years if the stock price starts to tumble.

The “clawback” provision is a good start. Empowering the shareholders is a nice idea, but it never works. Shareholders are too dispersed and diversified to monitor every executive in every company where they own stock.

Sure enough, says Pearlstein:

This year, as part of the Dodd-Frank financial reform law, companies for the first time were required to give shareholders a chance to vote up or down on executive pay in a nonbinding tally. So far, 98 percent of the votes have gone in favor of the pay packages.

But my larger point continues to be ignored:

But they — and their interlocutors in the press — are missing the real compensation problem.

The compensation that drove the crisis wasn’t in the general’s quarters. It was down in the trenches. The traders who manufactured and sold mortgage-backed securities were paid a fee every time they produced another MBS. They were not paid based on how well that MBS performed. They were compensated for quantity, not quality. They had every incentive to underprice risk and drive home prices to an unsustainable high.

The real compensation problem isn’t on the front page of the Wall Street Journal. It’s sitting at a trading desk just waiting for the next boom.

As true today as when I wrote it in September 2009.

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– Tyler Cowen (George Mason University)

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– Matthew Yglesias (Center for American Progress)

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• Probably the best article in the press about the compensation debate — as it is being considered by most people, not the problem I highlight — is here. It gives a little bit more depth than I went into.
• Lucian Bebchuk has been a very clear-headed expert during the crisis. I encourage you to read his plea for compensation regulation here.
• René Stulz is an outstanding — and in my opinion, underrated — financial economist. Awhile back, he made a sensible defense of derivatives against, dare I say, fear-mongers like Nassim Nicholas Taleb. (Taleb is correct on many points, but I think he takes it a bit too far on this issue.) Not only is Stulz a good researcher, but as an editor and administrator, he is responsible for a very important and long overdue shift in the profession. From Justin Fox’s The Myth of the Rational Market:

The Swiss-born, MIT-trained Stulz was no peddler of unconventional ideas in his own work, but his dozen years in charge of the Journal of Finance were marked by a dramatically more open editorial policy than under his predecessors. No longer did it take the special intervention of Fischer Black to get a paper that mentioned psychology or questioned market efficiency into the pages of the discipline’s flagship journal.

To a senior professor voting on whether to give a young colleague tenure, an article in the Journal of Finance was an article in the Journal of Finance, even if one disagreed with it. “He’s the big hero,” said [Harvard economist Andrei] Shleifer of Stulz. “He’s the person who brought this field out of the forest. He just said, ‘This is fine; we’ll publish these papers,’ and other journals began to follow his lead.’”

• I hope that little snippet also tempted you to buy Fox’s book. If you have any interest in finance or economics, it is a must-read. Buy it here.
• If you’re curious what research I was referring to with the “Great Man Theory” of CEO compensation, Princeton economist Uwe Reinhardt gives the theory an excellent treatment here and here. Cornell economist Robert H. Frank dissents here, but this is one of those rare times when I strongly question Frank’s argument. Two reasons: (1) He doesn’t give much evidence of the link between compensation and performance, which Reinhardt does (and finds it rather nonexistent). (2) He doesn’t give the matter his usual evolutionary touch. If he did, I think he’d find that organizations too often select leaders for reasons that are economically irrational and dangerous but were more useful in a primitive, tribal setting.
• The Michael Lewis quote is from his legendary Liar’s Poker. Lewis is one of the best nonfiction writers of our era, and Liar’s Poker is his masterpiece. It’s short. Read it. Now.

As always, a final reminder to read my original post.

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