Executive Compensation Limits: He Who Pays the Piper Calls the Tune
If the government is going to put taxpayer money into distressed firms, then it has the obligation to regulate every way that money leaves the firms before the taxpayer money is repaid. That includes dividends, large purchases, executive compensation -- everything. The government may decide that it is not feasible or constructive to micromanage the firms, but that is a decision it should make deliberately.
For me, the key word is "if." I think that the appropriate policy response is bankruptcy, not bailout in lieu of bankruptcy. In bankruptcy or liquidation, the question of whether the executives are being paid too much is moot. In bankruptcy, equity holders are wiped out and management goes with them unless the new owners -- the former creditors -- specifically wish to retain them. If they make that choice, then they should be able to pay the executives whatever they deem appropriate. Likewise if they hire new managers.
So this question only arises when we make the wrong policy choice of bailout in lieu of bankruptcy. What's the least worst way to do the wrong thing? As a taxpayer, I want competent people running the organizations that I expect to repay the funds. Almost by definition, we can assert that those running these organizations are not competent. The big problem is that they have not been fired. The small problem is that we may be overpaying them.
"For me, the key word is
"For me, the key word is "if." I think that the appropriate policy response is bankruptcy, not bailout in lieu of bankruptcy. In bankruptcy or liquidation, the question of whether the executives are being paid too much is moot. In bankruptcy, equity holders are wiped out and management goes with them unless the new owners -- the former creditors -- specifically wish to retain them. If they make that choice, then they should be able to pay the executives whatever they deem appropriate. Likewise if they hire new managers."
Thanks for the information
Market psychology
Do you have an opinion on the tradeoff between bankruptcy and bailout as far as market expectations. Several months ago many bloggers (I'd have to hunt for specific links) were decrying the decision of the Fed and Treasury to let Lehman fail, sending investors into a panic.
I.e. if the notion is that equityholders will be summarily wiped out, could that further exacerbate the problems of existing healthy banks by causing investors to dump their shares precipitously.
The Domino Effect
A tumbling equity market affects banks only to the extent that they have to go to those markets to raise new equity -- they have to give up more shares in order to raise a given sum of money. But the tumbling equity market does not affect the solvency of the bank itself.
I was not one of those bloggers decrying the decision to let Lehman fail. I was one of the bloggers decrying the decision to shovel money at AIG.
More on the domino effect
A falling share price would affect the ability of banks to raise new equity as you say, but could also trigger credit rating changes and debt covenants, that force banks to panic sell assets on their books.
There is no question in my mind that what one could call the "null hypothesis" is to let banks fail according to the terms of the equity and debt instrument. The rights of various claimants, the procedures to be followed etc are well understood and there is no need to invent policy under fire. (not to mention the longer term effect of incentives). When small banks fail this is what happens and the financial seems just fine if not better.
The question (and it is a question, not even a counterargument to you original post) is whether things should be handled differently for large institutions when the financial system is under systemic stress.
BTW I'm also not sure I understand the rationale for AIG's rescue either.
Without AIG prop all banks fail
Letting AIG fail was not an option because of credit default swaps. Lehman failure was an experiment (a la Paulson) that showed just how exposed and fearful all other banks are vis a vis CDS instruments. Prior to Lehman failure this risk wasn't even close to quantifiable, and it still isn't. Nobody knows for sure, and that's the scary part. Paulson and Bernanke didn't have a clue.
http://www.npr.org/templates/story/story.php?storyId=94748529
AIG is the largest player in the $71 trillion credit default swap market.
The problem is there is no transparency in the system and nobody knows who has what exposure. In this environment panic sets in and nobody trusts lending to ANYBODY, and you get even worse version of what we are going through now (credit freeze) on a global basis.
"The pure size of the CDS business is enough to make a failure of AIG a threat to the entire global economy. What's more, the CDS market is far from transparent. "Nobody knows exactly who has them and where they got them from," Davidson said. The fear is that AIG has insurance banks all over the world for trillions of dollars that would suddenly be at risk. If AIG collapsed, banks would stop lending money to each other.
"If that stops, global economic activity stops," he said. "We don't know that that would have happened, but it seemed like a real possibility. And that was why the government stepped in.""
Announce Repeatedly the Bankruptcies Will Happen--Then Follow-Up
Lehman and AIG were both policy fiascos; in both cases, the possibiity of a last-minute bail-out prevented market participants from getting out of Lehman debt or AIG CDS's gradually as bankruptcy loomed-- and was fully anticipated--over a 6 month period. Treasury/Fed intervention should be limited to providing debtor-in-possession financing.