Bebchuk on pay

Posted by Marc Hodak on August 4, 2009 under Collectivist instinct, Executive compensation | 3 Comments to Read

Lucian Bebchuk is editorializing on compensation regulations again, proposing that bank compensation is too important to be left to the banks (or, more precisely, to their boards).  Like any good debater, he attempts to address the objections put forth by critics of his position.  I think he kind of stumbles on this one, though:

Furthermore, limiting structures that incentivise risk-taking is not more demanding in terms of information than regulators’ traditional intervention in investment, lending and capital decisions.

Not exactly a confidence booster, huh?  (I’m visualizing the smart guys in Basel grinning nervously, asking, “Hey, what could go wrong?”)

Look, Bebchuk offers perhaps the best defense of certain proposed compensation regulations around.  He is thorough, insightful, and moderate by the standards of current political discourse.  In this case, he is not relying on his mistaken managerial power thesis to defend what he describes as a problem of externalities.  But in the end, he makes the same error in assuming that developing optimal pay structures is something that anyone can do if they just think about it hard enough.

Developing good compensation mechanisms is not an exercise for amateurs.  Even the experts get it wrong when they are acting in good faith.  To expect a regulator, or any non-interested third-party to develop optimal compensation contracts for both the firm and society is like asking a committee of lawyers to develop a surgical strategy for treating leukemia; you know there’s a problem there, but it assumes the people you’re asking to solve it know what the right questions are, let alone the right answers.

I say, let the regulators show that they can regulate investment, lending and capital decisions–which at least have a basic theoretical ground of common understanding–before unleashing them on incentives, which can multiply the effects of unintended consequences.