Will the Credit Crisis Foster Convergence in Executive Compensation? (And Do We Really Want It To?)

The American public has lately been riveted by the almost daily news stories on the recklessness and irresponsibility of the executives widely seen as contributing to the credit crisis. These reports and the unfolding crisis have shifted the debate over executive compensation from merely reigning in excessive pay to proposals calling for punitive or retributive measures, such as imposing personal liability on the executives at the helm of failing companies. But as we debate throwing executive salaries to the mob, as Nate Oman discussed in his recent thought-provoking post, it’s worth examining the experiences of other countries that have already gone down this punitive path—and are now turning back. It’s also important to consider what this debate reflects about our conflicted attitudes towards credit and debt, in particular the link between tolerance for financial failures and entrepreneurship, and how the credit crisis may be changing these perceptions.

Not long ago, “American pay packages” were portrayed as a symbol of America’s commitment to fostering and rewarding innovation and entrepreneurship. Enormous pay packages were cited as the fruits of a system where any dream could come true, and contrasted with those in other countries where risk-taking and entrepreneurship were more constrained, less lucrative, and even tarred with the stigma of failure and shame. In Japan, for example, during its credit crisis of the early nineties, executives were forced to take pay cuts as a form of apology to an unforgiving public. Executives in some European countries could be held personally liable and even face imprisonment for failing to avert bankruptcy.

As calls for more punitive measures intensify in the U.S., and as our executives begin promising pay cuts in return for bailout funds, we may be heading towards a harsher system just as other countries reverse course.


In Europe, for example, policymakers are attempting to ease the stigma and barriers associated with bankruptcy, hoping that facilitating forgiveness for financial failures instead of punishment will stimulate entrepreneurship and innovation. (See Overcoming the Stigma of Business Failures: For a Second-Chance Policy). Japan has also moved to encourage rehabilitation for failing businesses.

If the fallout from the current credit crisis pushes the U.S. towards greater convergence with countries that penalize or stigmatize financial failures, we should keep in mind the potential impact on our culture of risk-taking, forgiveness, and the opportunity for a “fresh start.” On one level, holding executives increasingly liable for business failures may create a morally satisfying symmetry with the recent changes in our consumer bankruptcy laws, which, in the name of increasing “personal responsibility” made it more difficult for struggling consumers to walk away from debt repayment. (See here for a discussion of how the 2005 bankruptcy reforms, by making it harder for consumers to obtain debt relief, may exacerbate the fallout from the collapse of the housing bubble). It’s also difficult to sympathize with executives who collect millions while ordinary employees struggle; executive pay levels have risen beyond sustainable or justifiable levels and should be cut.

But there’s a significant difference between reducing pay and imposing liability. On a broader level, if we choose to continue down a path which increasingly stigmatizes and penalizes business or financial failures, whether corporate or personal, we may end up with more at stake than just the personal culpability of individual executives or consumers.

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3 Responses

  1. Brian Greer says:

    I think you are wrong. I do not have a problem with a CEO involved in the founding and initial development of a company getting their big payday when they have built up a company from nothing into a major player. I get frustrated with these mercenary CEOs who appear to largely create nothing, beyond excessive compensation packages and employment contracts that only a lawyer could be proud of. These are manager CEOs, not entrepreneurs. Many of these have never created anything. They just know how to climb the management ladder and squeeze a few more pennies from here and there by riding the most recent management fad (downsizing, outsourcing, offshoring, etc).

  2. Anon says:

    Of course, Shruti is correct. The problem is not that executives are paid too much, it’s that the shareholders—the company’s owners—fail sufficiently to oversee what their managers—employees—are doing. One would be unlikely to see such owner-negligence in a small business. So, if you fail to watch what your employees are doing, and you fail to notice their bad deals, and your company goes under, the shareholders rightfully lose their equity and the managers rightfully lose their jobs. The line workers should just go work somewhere else.

  3. A.J. Sutter says:

    I agree with Brian. Some other points that Shruti seems to overlook:

    @ the disparity between CXO pay and average worker pay is much higher in the US than in other countries (esp. Japan).

    @ Also as for Japan, the people most in need of rehabilitation are entrepreneurs, especially of SMEs, who otherwise would have ruined lives after bankruptcy.

    @ Public companies face special moral hazards because of the stock option-compensated executive team. Start-up or SME bankruptcy and self-interested mismanagement of public companies are not the same thing.

    @ Most of the public ire at this moment is with financial services execs, whose behavior was particularly arrogant, as well as being fantastically stupid. (See, e.g., Janet Tavakoli’s Structured Finance and Collateralized Debt Obligations, 2nd ed.(2008).) As for the auto execs, it’s true that they too have behaved stupidly and insensitively; though I think peoples’ eagerness to see those companies collapse takes too lightly the impact on huge numbers of workers and others. Still, I don’t think forgiveness of the stupid is as important in the auto company case as is compassion for the relatively innocent.

    As for “Enormous pay packages [being] cited as the fruits of a system where any dream could come true,” this was a false impression, fostered more often than not by the beneficiaries of those enormous pay packages. What about the dreams of the line employees, for example — were they more likely to come true because the CEO was taking huge tranches of cash on joining, running, and leaving the company?

    In sum, I think one should be more careful to distinguish between small company and big public company issues, and also not to wax unduly sentimental about the loss of a false narrative.