The secret genius (and hidden consequences) of the pay cap

While it almost certainly will do very little to curb the obscenely high salaries of many in finance and business, the Obama administration’s new pay cap for execs at federally bailed out companies could actually help revive key portions of the financial community and could save the government billions. Because just as we thought private equity and hedge funds were on the ropes, the new policy is bound to incent the best and the brightest at big financial firms that are struggling to move out to work in firms where the only caps they will encounter will be on the heads of their doormen and caddies. And tax-payers will benefit because top management and troubled firms will be more likely to do just about anything to avoid taking cash from the government now that there are strings attached. Of course, these rules are retro-active which makes those masters of the universe at Merrill, B of A, Citi, and AIG look great for having had the genius to fail first and thus not be subject to them. 

On a more serious note, as for the promise woven into yesterday’s announcement — that the Administration will be looking for other ways to curb excessive salaries in the future, while broad stroke mandating of pay-levels seems unlikely — it does raise some interesting questions.

For example, while it is hard to imagine how the government could regulate salaries in private companies that aren’t taking tax-payer dollars, it’s equally hard to understand why one set of companies receiving tax-payer dollars should be treated differently from another. So, if I were a financial services executive who had to set aside my Lamborghini catalogue, I might ask what the government will next do about say, the compensation of defense and aerospace executives whose companies largely depend on revenues from the USG. According to Forbes, for example, in 2007 average total compensation of CEOs of defense and aerospace firms was $20.6 million. (Average Fortune 500 chief execs earned “only” $12.6 million by comparison.) So these guys are also getting rich feeding at the public trough.

Back to you, Mr. President…

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