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executive compensation: Fairness AND Equality? by S i n d h u r a C h i t t u r i ( ‘ 1 3 ) Sindhura is a freshman at the Wharton School, and a member of the College Republicans Club at the University of Pennsylvania.

T

he debate over executive compensation rages on, although nearly a year and a half has passed since President Bush signed into law the Troubled Asset Relief Program (TARP), which effectively rescued Wall Street banks from the consequences of their own risk taking. Many of the banks that received government assistance paid their executives millions of dollars in bonuses, angering Americans as well as Washington. The clash over executive compensation is much more complex than disputes over everyday economic issues given the unprecedented nature of the TARP bill. Typically, economics does not involve concepts such as fairness and equality, but because the government funded the bailout with taxpayer money, these concepts are more important than ever before. Therefore, Congress is justified in restricting executive compensation on Wall Street. Those who argue against government restrictions on executive compensation believe the matter should be determined by the free market. Yet, their argument means little today, since the whole reason the debate is taking place is because the government had to rescue banks from the forces of the free market. Left alone, these banks would have indisputably failed. For years, Wall Street reaped the benefits of excessive risk taking and over-leveraging, but when the bubble burst, did not have to pay the costs because the government intervened. In order to make banks accept responsibility for their actions

and recover some of the cost of the TARP bill, Congress should impose a tax on bank bonuses. Great Britain recently imposed a 50% payroll tax on banks that pay workers bonuses more than £25,000 ($40,750). The United States should move in a similar direction.

Wall Street argues that taxing bonuses will make it harder for banks to retain the so called “best and brightest” executives. This statement could not be more inaccurate. It is doubtful that these executives really are the “best and brightest” since they propelled the country into the financial crisis. And even if they are, elementary economics teaches us that people alter their behavior more significantly when they foresee a future change in their income. If Congress imposes a onetime tax on bonuses, executives will not leave the financial sector. If arguments about egalitarianism and economics are not enough, it is actually in the banks’ self-interest to restrict executive compensation.

Multi-million dollar bonuses that occurred while thousands of Americans lost jobs have evoked feelings of populism. Wall Street should remember that the last time populism was this strong, things did not bode well. In September of 2008, the TARP bill initially failed because populist feelings were rampant. At the time, members of Congress voted against the TARP bill because their constituents voiced outrage over the legislation. Banks are jeopardizing their chances of receiving government money in a future financial crisis by not limiting executive compensation. Even if Congress places restrictions on executive compensation, the financial crisis has shown us that executive compensation must be reformed. Today, many firms determine executive compensation based on individual shortterm performance. We know only too well that this can lead to executives making decisions that are clever and beneficial in the short-term, yet imprudent and harmful in the long-term. In the future, firms should instead base executive compensation on individual long-term performance. The firm’s overall performance should also play a role in determining bonuses because it would give executives an incentive to make the firm succeed. Moreover, basing bonuses on long -term firm performance would prevent firms from paying record bonuses in years that they suffer record losses. As Congress moves to restrict executive compensation, now is the time for firms to reform. iBR

i n t e r n at i o n a l bus i n ess r e v i e w

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International Business Review - Spring 2010  
International Business Review - Spring 2010  

The Spring 2010 edition of the IBR.

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