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Monday, December 22, 2008

Excessive Wages - A Reality

Traditional economists look at large compensation packages paid to 'important' CEOs and the like and they point to the high stress, amount of innovation and education, and high personal risk and time necessary to maintain such a position as justification for wages paid. After all, it is the 'free' market that is deciding these wages, right? Not really.

The 'free' market is subject to cultural norms - norms that allow executives to not only want but to expect high pay or their work - regardless of how hard they work at their jobs. They expect to fly corporate jets and to pay for lavish parties with company money. It's a perk, not a necessity for them to take or keep the job.

Take Goldman Sachs:
"Lloyd Blankfein, president and chief executive of Goldman Sachs, took home nearly $54 million in compensation last year. The company's top five executives received a total of $242 million."

I gotta tell you, $50 million a year is a lot of money - for anyone. But being CEO of a major financial firm is pretty cool by itself. Most people that are attracted to such positions are type A personalities and are only driven by money as an initial motivator. Their main motivation is to stay busy and the work itself. They live to work - that's why they got to the level they obtained as corporate executive. So, would they take $40 million, $30 million, etc. for the same job...most assuredly. Again, the bulk of that money is just an expected perk since that's how it has been done across the industry for decades. Basically, corporate executives have collective bargaining power over their industry (financial) simply due to the norms of the industry itself.

And therein lies the problem for the free market - and one that requires government regulatory solutions: An individual company would be foolish to pay lower than X amount since, due to market forces, as long as another company would pay X amount, the first company would be unable to attract quality CEOs ("quality" is debatable in light of recent events). This is a game theory problem. The only way to break the habit of excessive pay is if a third party jumps in and limits the pay across the board such that the playing field isn't skewed to favor one firm or another.

And therein lies the problem for the government: it is almost impossible to maintain a level playing field. For example, the TARP funds right now are being distributed basically by whomever the Fed decides is worthy of the funds. This kind of government involvement is largely subjective. The solution could end up being worse than the problem. The upside is Obama has chosen to surround himself with intelligencia - let's hope it's the right kind. Whatever that means.


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