The folly of executive pay caps

Obama’s new proposal of imposing executive pay caps on firms that receive government bailout money has a problem as seen in USA Today and other places: Since firms that are doing well don’t have the pay caps, there may be a “brain drain” wherein the “best people” won’t want to work for the companies where the limits are in place. According to a “compensation consultant” named Alan Johnson, “[…] you end up killing the institution you tried to save […] You drive away the good people.”

Hard to deny that. You want to “save” a company via cash injection, but at the same time you put a limit in place that will tend, over time, to lead the best people away from the company. The implied upshot of this is that we shouldn’t be imposing a salary cap. I’d like to take this a step farther, and suggest that we shoudn’t be trying to “save” them with cash in the first place! Clearly, there is a range of results in the financial industry, where lots of companies feel like they need a handout to keep going, whereas some are apparently doing OK (e.g. the ones who would theoretically pull talent from the ones where the caps would be applied). It seems to me that we should let the market take care of this. Those companies that are doing the worst should risk going under, just like any other industry. If they do, their competitors can buy up their assets, including their previous customers, etc.

The fact that we even consider bailouts for behemoths like the automobile industry and the financial services industry seems to prove that the US “market economy” is anything but. Like Newton’s laws of physics which break down in conditions with extreme velocities or extreme scales, our concept of the free market seems to break down when actors in the marketplace are extremely large.