Wednesday, October 21, 2009

The law of unintended consequences, Washington edition

It has just been announced that Washington is clamping down on executive pay for seven of the companies that received the most government money.

Here's one of the articles.

And here's the money quote:
"Under the plan, which will be announced in the next few days by the Treasury Department, the seven companies that received the most assistance will have to cut the annual salaries of their 25 best-paid executives by an average of about 90 percent from last year."

Let's think this through for a second.  What will this actually accomplish?
  • These people who are about to take a huge pay cut will all quit their current positions.
  • At these below-market salaries it will be nearly impossible to fill these positions.
  • These companies will have to be really innovative in designing comp plans to fill these positions (in case you weren't paying attention, innovative comp plans were a significant part of the problem.)
  • You can't promote anyone in to those positions because of the pay cut you would be asking them to take* (hat tip Alex Tabarok at Marginal Revolution, who also used an Ayn Rand reference in his article.)
  • No one will want these positions because all of their direct subordinates will be earning vastly more than they are.
  • These seven companies will be leaderless.
  • So who, exactly, will do the work of finding new executives to fill these positions for these companies?
  • While they are leaderless they will lose significant market share and thus value.
  • These companies' odds of survival have been severely diminished.  
  • The reduced value of these companies means that they will be even less able to repay us, the taxpayers.  And it increases the odds that some or all of these companies will fail outright and lose all of our money.
  • When these companies deteriorate even further the government is going to have to take them over and run them directly.
  • Every other company that has taken government money is now in an absolute panic to pay the money back ASAP.  To hell with earnings, market share, shareholder value, or any such thing.  The executives at the rest of the companies must repay that government money immediately or risk taking their own pay cuts.
  • That rush to repay the government money will dry up the liquidity that the money created.
  • No business will ever trust the government again.  There can be no TARP II, because no executive in his right mind would ever accept the money.  (This might not be a bad thing, necessarily, but it certainly disarms the government from being able to address the next crisis this way.)

This is all kinds of stupid.  This is knee-jerk legislation that makes brownie points with the voters at the expense of the best interests of those voters.

This should be canceled and the person(s) who proposed it needs to be publicly fired, before business leaders get in to panic mode.  "A man who has committed a mistake and doesn't correct it is committing another mistake." - Confucius

This action is intended to solve the false problem that these people are getting paid to much.  That is not the problem.  The problem is that these people are getting paid for very short-term success instead of long-term success.  Government can take some time to put some reasonable rules in place that tie compensation to long-term performance.  As long as the new rules are not straight pay cuts.

Team Obama needs to re-read Atlas Shrugged.  Ayn Rand was wrong about a lot of things, but she perfectly predicted how socialists will destroy every productive company that they can get their hands on.

According to Ayn Rand the next legislation will be a rule that these people cannot quit.  The consequences of that will be that they all go play golf full time instead of doing the jobs that they are no longer getting paid for.

Applying the wrong solution will always make the problem worse.  That is my own corollary to the law of unintended consequences.

* The promotion problem explanation:
Let's say that your 25th best paying job pays $1M/year.  Some people in the top 25 paying positions quit.  You reshuffle and want to fill just that 25th best paying job.  You go look at the person in the 26th best paying job and try to promote him/her.  That 26th job person is making $950k/year.  The 25th job was busted 90% and only pays $100k now.  That 26th person is not going to accept that promotion and give up $850k/year.


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