Executive Pay
June 19, 2009
Americans are furious about the big bonuses Merrill Lynch and AIG paid their employees after receiving federal bailout money, and the government is looking to control salaries at the bailed-out firms.
But Kevin Murphy of the USC Marshall School believes that imposing executive compensation caps could weaken our economic health.
Murphy addressed Congress on the subject in June, at a panel seeking new laws on executive pay. “Regulating compensation in financial services more broadly will cripple one of our nation’s most important and historically most productive industries,” he testified.
According to Murphy, basing pay on objective assessments of an individual’s performance is impossible — and “part of why we’re in this mess in the first place.”
Murphy urged Congress to consider the mortgage brokers who were paid for writing large numbers of loans, rather than for writing loans that borrowers would actually pay back. “A solution to this performance-measurement problem is to pay people to write ‘good loans’ and penalize them for writing ‘bad loans,’” he testified.
Murphy recommends that companies avoid rewarding short-term results and paying bonuses all at once. “Pay them over a period of time to make sure the performance is real,” he advised.
It’s not in the taxpayers’ best interest to eliminate bonuses or cap executive pay, according to Murphy. “Banks are losing their best people, who are starting their own hedge funds. These are precisely the people who understand the complex interests that got us into trouble. If they leave, there’s no one there who understands what the risks really are.”
Addressing the public outrage over executive salaries, Murphy says: “The anger is understandable. But we shouldn’t make policy decisions when we’re angry.”
Kevin Murphy, holder of the E. Morgan Stanley Professorship of Business Administration at the USC Marshall School, is an expert on executive compensation and corporate finance. He is editor of The Economics of Executive Compensation (1999).