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Benjamin W. Heineman, Jr.
Legal Scholar

Benjamin W. Heineman, Jr.

Business ethics expert; senior fellow at Harvard’s schools of law and government; former General Counsel for General Electric; former assistant secretary for policy at the U.S. Department of Health, Education and Welfare (now Health and Human Services.)

Pitchfork Populism

Finding a new balance between public regulation and private decision-making is a paramount issue of the time. The crisis in capitalism stems from the systemic failures of business judgment in the financial sector which have caused the credit and solvency crises and led the world to the brink of depression. It is now a commonplace that 30 years of financial deregulation has come to an end.

There is a new consensus on the need for sensible public policy to deal with the causes of private excess and to ensure the safety and soundness of the financial sector going forward -- to reconstruct the basic foundation of the world economy by finding a proper new balance between public and private decision-making. Numerous reports have been published both in Europe and the U.S. on regulatory visions of the way forward. This week the Obama administration will unveil its financial re-regulation proposals (as well as new ideas on how to deal with the "effects" of the melt-down -- the toxic assets which pollute banks' balance sheets).

But, lurking behind the consensus, along all points on the political spectrum, is the concern that regulation has problems too. High among those is recognition that decisions in the public sector can often be driven by irrational politics rather than sensible policy -- by passions expressing the feelings of the moment, unmoored from sound judgment, which mirror the passions like greed and corruption that have hobbled the private sector.

The AIG bonuses are a microcosm of the problem. The Financial Products Group made terrible mistakes that had enormous, adverse multiplier effects. As financial conditions worsened, any incentive pay should have been carefully tied to positive results. Once those conditions turned into financial disaster and virtual government takeover, AIG and the administration should never have let the bonus money out the door -- their justifications of legality and retention were not credible in the narrow case of the senior employees at the Group. Predictably, the actual payments have fanned flames of public outrage.

But the House bill, imposing a 90 percent tax on all 2009 bonuses for all TARP companies receiving government funds of more than $5 billion is nonsensical as a matter of policy (putting aside questions about constitutionality).

Leadership is about defining problems correctly. If they measure real contribution to an enterprise over time -- real performance with integrity and sound risk management -- phased bonuses are an important incentive, not bad per se. This can be especially important going forward as we seek to repair financial institutions. The blunderbuss House bill has any number of bad impacts: failing to recognize the value of good bonuses; driving people out of financial services; driving companies out of government programs.

Most importantly, the House bill undermines the credibility of public regulation and the importance of sound policy responses to the crisis. It is pitchfork populism -- exactly what thoughtful people fear.

I believe deeply that terrible executive compensation systems were the rocket fuel that drove the financial sector to disastrous excess. And the public is rightly outraged about past pay practices and amounts. But finding the right future balance between government regulation of executive pay to ensure safety and soundness and private sector incentives for sensible innovation and wealth creation is one of the hardest problems at the core of the new re-regulation consensus. Driving talented, blameless people away from regulated entities cannot be the right result.

President Obama (and the Senate) must reject the House bill and go back to the more thoughtful executive compensation proposals he announced a month ago, which invites a sensible, future dialogue between government regulators and affected corporations. Past failures should be handled and explained sensibly case-by-case for individuals responsible for failure, not mishandled as with AIG Financial Products Group leaders. (And, when passions abate, a Dodd amendment to the stimulus bill that arbitrarily limits bonuses also needs to be modified.)

Nothing less than the credibility of public regulation is at stake, with implications far beyond current anger over executive pay as the watershed re-regulation debate begins in earnest.

By Benjamin W. Heineman, Jr.

 |  March 22, 2009; 10:31 PM ET
Category:  Presidential leadership Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati  
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Wrong. Thoughtful people do not fear "pitchfork" populism. The expression itself is demeaning and offensive. The "pitchfork" implies that lowly bumpkins have no business raising their voices to their betters. It's high time the American started paying attention and take note of what financial and political elites have been doing -- robbing the country blind, to put it plainly. Look mister, I'm sure I'm considerably poorer than you are, but I'm just as at home in New York and Paris as you are. I have a clue or two about where to go to get reliable information, and I have a sensitive nose for propaganda. Don't you dare tell me to put down my pitchfork, and don't you dare claim to be more thoughtful than the rest of us.

Posted by: Aformerjournalist | March 23, 2009 1:26 PM
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The really problem is that executive compensation moved from pay-on-pay to pay-on-action.

The people receiving the compensation had little or no risk in the game. I'm reminded of that scene from the movie Wall Street where Michael Douglas's character, Gordon Gecko, is giving a speech (http://www.youtube.com/watch?v=GQnCFdjLJAM). He laments that the executives have no stake in the company. Most of the problems we have today are directly tied to wealth without comparable risk. Whenever the opportunity exists to earn money without a comparable amount of risk you can expect poor decision making.

If you are hired to be CEO for a company run by a private equity firm do you think they'll give you a $20 million to fail? Absolutely not, their compensation plans are tied to their short-term and long-term objectives for the company.

We have CEOs earning $10m+ a year for 3 years only to leave and watch the decisions made on their watch unfold disastrously. Now, imagine if those CEOs had been told they had to invest 75% of their net worth in the company and 90% of their compensation would be paid each year in stock that could not be sold for 5 years. Do you think we would get a different set of results?

I've worked for entrepreneurial companies and have watched them grow to $250M+ businesses. When the people running the company have most, if not all, of their and their family's wealth tied up in the business they manage it very differently then many public companies. They care about every risk taken and every dollar spent.

We don't need less compensation, making money is a great thing (the more the merrier). We need compensation that is closely tied to actual cash generated and actual risk exposure. For highly-paid ($500k+) individuals companies should set long-term comp plans that pay when their bets pay off - even if they have left the company - and require they have substantial portions of their net worth at risk if they can make money from the company's risk-taking.

Posted by: nicknow1 | March 23, 2009 1:20 PM
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