Bankruptcy

The Bailout -- another perspective (part 4)

By Stephen Lubben

I want to thank the Credit Slips folks for allowing me to drop in unannounced -- I'm off to talk with the bankruptcy judges at their annual meeting, so I expect this will be my last post on the topic (barring any dramatic new developments).

I want to talk a bit about executive compensation, to my mind one of the thorniest issues in the entire bailout debate.  Normally I'm reluctant to get too worked up about executive compensation -- if shareholders are not getting worked up about it, it's not my money at stake.  And executives will have to deal with the reputation costs of gorging at the trough.  Clearly they have done a poor job of explaining why high levels of compensation might be justified.

But the bailout raises somewhat different issues in the sense that it is my money backstopping alleged excessive risk taking.  On the other hand, I tend to agree that the current proposal on compensation appears to be useless and hopelessly vague.

One idea I like -- first suggested to me by my friend and colleague Eddie Hartnett -- would involve a retroactive tax on executive compensation that can be attributed to excessive risk taking.  The idea is to tax the conduct that created an externality -- namely, the federal bailout -- and deter such conduct in the future.  The plan is relatively simple:  we'd assume that for any firm selling assets into the bailout fund, executive compensation over a fixed level ($5 million per year?) for the five years before the bailout is attributable to excessive risk taking and subject to a heavy tax.

Eddie assures me that the retroactive aspect of this should not present a constitutional problem -- he's got lots of fancy Supreme Court cites, but this one should get you stared:  512 U.S. 26, 114 S.Ct. 2018. 

I like the proposal because it does not penalize new management who might be brought on to fix problems at these financial firms and does not get the government involved in the inherently impressionistic task of figuring out what compensation is "excessive."  At the same time, the tax creates a deterrent effect for future financial calamities.

(edited to fix several annoying typos)

Full post as published by Credit Slips on September 24, 2008 (boomark / email).