The latest example of misguided congressional meddling comes in the form of proposed regulations on corporate executive pay. My old friend Rep. Barney Frank, Massachusetts Democrat, is about to introduce legislation to require corporate shareholder review of executive compensation. It all sounds very nice. After the high-profile corporate scandals of the past few years, who could be against cutting the high payouts to corporate leaders?
Armey’s Axiom says that demagoguery beats data in the making of public policy. While attacking executive pay across the board in this manner has populist appeal and is rhetorically clever, it is still a bad idea.
The vitality of the American economy results from thousands and thousands of ongoing experiments. Entrepreneurs take an idea and test it in the marketplace. Some ideas are about new products or methods for production, sales or marketing. Still other innovations are in the organization of a firm, its management system and even in the ways of measuring, monitoring and compensating its employees. Markets reward successful entrepreneurs and innovations. Just as importantly, however, markets will punish bad ideas and inefficient behavior. Justice for corporate malfeasance is swift and brutal, as was seen in plummeting stock prices for Enron or Tyco once scandal emerged.
By contrast, oftentimes efforts by Congress to “protect” shareholders from self-serving corporate executives tend to insulate bad actors from market forces and perpetuate poor performance.
Clearly the top-performing CEOs in corporate America earn every penny of their compensation and then some. They create wealth, and by doing so create shareholder value, increased consumer welfare and higher standards of living.
Publicly held companies are designed to maximize profit to their shareholders. Inevitably, some firms will employ poor managers and occasionally a really bad actor. Unless the firm has a strong system for monitoring the quality of executive decision-making, the market will pass judgment quickly in the form of lower or negative returns on investment.
The problem with a one-size-fits-all approach to executive pay is that it punishes the vast majority of the market — where wealth-generating firms and shareholders reside — in order to get at a handful of bad actors who would otherwise be dealt with through market forces.
There is a healthy dose of arrogance in the idea that another law could beat an entrepreneurial marketplace for determining how to evaluate compensation. Poor executive performance shows up quickly on the bottom line. Heaped on top is the misplaced notion that since Congress is engaged in politics and government all organizations should have the same objectives and structures. Governments exercise force and create rules. By contrast, firms create wealth and create the opportunity for people to exercise their freedom to choose, to contract, to buy and to sell.
Perhaps shareholders should vote on executive compensation. But that should be for each firm and its shareholders to determine. Maybe it would provide a competitive advantage. More likely it would not. As a result of widely distributed ownership, most shareholders do not have the proper incentives or information to monitor the performance of executives.
Based on my experience in the House of Representatives, it is quite possible that many members of Congress might fully embrace the idea. But surely some wise soul will propose an amendment to the “Shareholder Vote on Executive Compensation Act” to provide for a similar stand-alone public referenda on congressional pay. The bad behavior, criminality and poor judgment we have seen in the private sector clearly have their parallels in the public sector. Perhaps what is good for the goose is good for the gander.
One way to test whether shareholders in a given enterprise would benefit from direct control over the compensation of senior managers is to tie congressional pay to public referenda. But I do not see that getting through Mr. Frank’s committee anytime soon.
Dick Armey, House majority leader between 1995 and 2002, is chairman of FreedomWorks, a national grass-roots advocacy organization.