BABE RUTH made the classic case for performance-based compensation in 1930, when a reporter informed him that he was asking for a higher salary than President Herbert Hoover. “I know,’’ said the Babe, “but I had a better year than Hoover.’’ Ruth’s prideful dig at Hoover expresses a principle that the Treasury Department’s “special master for compensation,’’ Kenneth Feinberg, is beginning to apply, rightly, to the pay packages of top executives at seven financial firms that received billions in bailouts from the taxpayers.
The firms’ highly leveraged, high-risk bets on such things as derivatives and credit-default swaps nearly caused another Great Depression. Executives and traders were lured into disastrous gambles by a system of incentives that rewarded short-term windfalls at the expense of long-term financial soundness. If another wealth-destroying financial bubble is to be avoided, that incentive system must be changed.
The point of such changes should not be merely to placate the public’s outrage at the exorbitant sums taken home by executives at companies that were rescued from bankruptcy by the taxpayers. The point must be to shift the reward structure in the financial sector from short-term killings to healthy long-term profitability.
Feinberg has made a good start by requiring a substantial portion of executive compensation to be moved from immediate salary to stocks that cannot be cashed in for several years. As he examines executive pay contracts at the seven bailed-out firms over the next two months, the “pay czar’’ should also make those compensation deals public. The taxpayers have been made stakeholders in those companies; they are owed that.
Ultimately, the new incentives Feinberg are supposed to create will only work if they are adopted as best practices across the financial sector. And to answer the complaint that such rules will drive the best and the brightest abroad, the Obama administration should work for an international compact on executive compensation in the financial sector. European governments are eager to join in such an agreement. The idea would be to reward steady Ruthian performance, not those masters of the financial universe who presided over a debacle of Hooverian proportions.
