Europe’s Bogus Bonus Caps

Such caps only distract from the true public scandal of finance: too‐​big‐​to‐​fail guarantees.
March 11, 2013 • Commentary
This article appeared in National Review (Online) on March 11, 2013.

Last week, the finance ministers of the euro‐​zone countries voted to limit bankers’ bonuses. It’s not difficult to understand the motives here. Investment bankers have had it easy in this crisis: Thanks to massive bailout programs, not a single European bank has gone bankrupt since late 2008.

But on the other hand, it seems a bit odd for European governments to worry about excessive banker pay while spending wildly to keep banks afloat.

Specifically, the euro‐​zone group of finance ministers agreed that shareholders should have to approve a banker’s bonus once it exceeds the banker’s salary, and that bonuses of more than twice a banker’s salary should be forbidden altogether. The move has stirred relatively little controversy — only Britain’s chancellor of the exchequer, George Osborne, has pledged to fight the measure.

Incidentally, last weekend, the Swiss voted in a referendum on a detailed proposal guiding the remuneration of corporate executive and board members, known as the Minder initiative. The measure, approved by a sizable 68 percent majority, bans certain forms of compensation, including so‐​called golden parachutes and bonuses tied to mergers and acquisitions, and ties other remuneration to stringent approval requirements by shareholders.

While it is easy to understand the sentiments behind them, the current initiatives are misguided. The European Commission claims that “excessive bonuses [at banks] led to excessive risk and taxpayers having to step in,” but the reality is quite different. Rather, overpaid CEOs and their bonuses have been a symptom of the implicit guarantees extended to the financial industry by policymakers, which also happen to encourage excessive risk.

And further, the Minder initiative can hardly be a well‐​targeted response to risky bank behavior and the cost of bailouts: It imposes a one‐​size‐​fits‐​all model of corporate governance on all companies, whether or not they operate in financial services, and whether or not they have received public money.

Notwithstanding the widely publicized cases of seeming excess — such as the $76 million worth of shares given to the CEO of Credit Suisse in 2010, just months before the company cut 2,000 jobs in response to a weak global recovery — shareholders already have effective mechanisms to discipline companies’ executives. True, there are situations when shareholders fall prey to fraudulent or predatory behavior. But can a uniform regulation of executive pay prevent those?

Consider Enron. The massive fraud by its executives, with the help of auditing firm Arthur Andersen, occurred under the full oversight of regulators. Non‐​transparent accounting rules that assigned a huge role to auditing firms created a false sense of security among investors. Similarly, attempts to regulate executive pay could be seen as relieving shareholders of one of their key responsibilities. It will hardly incentivize them to be more vigilant.

The fall of Enron was actually an instance of the market doing its job. The company and its culpable auditor, Arthur Andersen, are out of business. In sharp contrast, the now‐​common notion of “too big to fail” effectively eliminates bankruptcy as a disciplining device of the market. When it comes to corporate plutocracy or cronyism, especially in the financial sector, executive pay is a very minor part of the problem. Much more scandalous is the extent to which our financial institutions are shielded from losses through the use of public money.

Reasonable people may disagree about whether Europeans and Americans should let big financial institutions fail. But whatever one’s take on that question, the debate over executive pay is just an adolescent distraction from the hard choices policymakers need to make.

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