Collision of conflicting incentives

Posted by Marc Hodak on May 5, 2009 under Economics, Reporting on pay | Be the First to Comment

Good bankers have an incentive to go to the places that offer them the most.  That’s simple.

Banks, like all companies have a powerful incentive to keep their best producers.  Right now, American banks with little prospect of soon repaying TARP are losing talent to hedge funds, foreign banks, and other non-government owned entities in droves.

The government has the incentive to avoid embarrassment about how much bankers get paid in times when banks are in trouble.  Officials have necessarily focused on large institutions, especially TBTF firms, and have crafted all sorts of brain-damaged rules to try to contain the pay of bankers at those firms.  However,  those rules don’t distinguish good bankers from poor ones within these large institutions.  That’s because compensation regulation is driven by headlines, while compensation is more complicated than headlines can capture.  Which gets us to another incentive.

The media has an incentive to provide blaring headlines, which is how they sell stories.  One way to do that is to tap into the deep vein of envy that exists among the masses.  Most readers love to hate the “rich,” especially if they feel they can blame the rich for themselves being worse off.

This brings us full circle in the ecology of incentives.  Headline-driven media does not allow fine distinctions between good and bad bankers.  The compensation constraints intended to punish whole firms or industries invariably punish those that deserved their pay.  These deserving ones feel the same outrage at being punished for their success that the envious masses feel about the underserving ones getting paid anything at all.  In a bad environment, the best ones leave first.

Alas, there is a tension between economic news, which is sold with headlines, and economics, which is inherently nuanced.  That is why readers and presidents prefer one-handed economists.  Which is why only hacks do well in the media and in any administration.  The good ones do their best under the constraints of politics, pick up some real world experience, and go back to the cocoon of their ivory towers.

The rest of us are left anxious and confused.