Obama's $500,000 CEO pay limit is flawed. Here are four better ways to fix the executive-compensation debacle.

Making government work better.
Feb. 18 2009 12:30 PM

The $500,000 Limit Is Not Enough

Four better ways of fixing the CEO pay debacle.

Merrill Lynch CEO John Thain. Click image to expand.
Former Merrill Lynch CEO John Thain 

President Obama's $500,000 pay cap for senior executives at institutions receiving taxpayer assistance is a primal scream of outrage more than it is a coherent policy. But at least it begins a long overdue debate about the outrageous pay that has been tolerated—and, indeed, become the norm—in the senior ranks of corporate America. Americans are appalled by excessive CEO pay because they now recognize that the executives receiving these millions oversaw a grand fleecing of American investors, leading to the collapse of the national and global economy. In 1985, the ratio of the average CEO salary to the average worker's salary was 40-to-1. By 2005 it had metastasized to 450-to-1. Such increasing income inequality was tolerated as long as the rising tide was lifting all ships. Not anymore.

What should really be done about executive pay? First, let us acknowledge that the $500,000 bar is arbitrary. It will be way too low in some circumstances and way too high in others; it affects too few executives; it can be easily avoided through alternative pay techniques; and it injects the government into a sphere where it is uniquely inept—setting private-sector wages.

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If we are to stop outrageous pay, the objective should not be to match the foolishness of the Bush ideological embrace of wild-eyed libertarianism masquerading as capitalism with an equally foolish "government knows best" approach that ignores the market. We must create a genuine market for CEO services, generating meaningful competition and socially acceptable results.

This process should begin with some digging into history. The SEC, with its now well-focused resources and newfound vigor, should produce, in no more than 6 months, the authoritative report on the flaws in compensation decisions at major companies. The commission should subpoena the reports from compensation consultants and committees and reveal the biased methods they used to calculate pay, as well as the pressures they felt from their CEO clients. The SEC should map the overlapping and innumerable conflicts that result from service on compensation committees. And it should examine how compensation consultants were hired, by whom, and the representations made by the consultants before they were hired. This report will be deeply revealing and devastating about the back-scratching, fundamentally corrupt nature of executive-pay decisions.

Fixing the compensation debacle will require addressing the behavior of three groups: compensation consultants hired by boards, compensation committees, and, most importantly, institutional shareholders. These groups must rise up and reclaim power from a system that is now dominated by CEOs. Real progress will result not from an essentially arbitrary rule imposed by government but from a rejuvenated system of corporate governance with shareholders—the owners—having an adequate say.