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.