1) They respond to incentives.
2) They are rewarded exponentially for being the best.
I’ll begin by saying that I don’t closely follow “the financial crisis.” In fact I try to avoid thinking about it because thinking about it is a surefire way to know I’m being unproductive. That said, I occasionally get ensnared. This is one of those cases.
First, some very valid questions:
As long as executive pay is being dragged out into the gaudy light of mainstream media, i think there are some fair questions that should be asked:
Are the qualities that make for a successful “top executive” really so rare? what if a lot of these banks ascended to greatness based on the performance of 1 or 2 generations of truly brilliant minds, but have stayed on top largely because of their accrued resources, reputations, etc, while being run by guys who are not innately better strategists than your average wall street type? if this is wrong and executive pay really is matched with talent (with no upper-end plateau), how quickly does this drop off…i.e. how much “talent” are you losing with every dollar?
it’s entirely possible that there exists a virtually limitless pool of potential bank heads that could do the job as well for cheaper. what is the counter-evidence?
I understand these questions and I wonder them myself. But again i ask you, if salaries don’t reflect/proxy performance/value created, then why don’t all the stakeholders in all of the companies just cap management’s salaries?
Use any other industry as an analogy. Columbia University is one of the most prestigious research universities in the world. Why? Its scientists are often the first to publish new findings. Why? Because it attracts the highest tech machines and the smartest faculty? Why? Because it is well endowed. Why? Because it is one of the most prestigious research universities in the world. Success is self-perpetuating because the best want to be around the best.
If you reduced Columbia’s prestige or the resources available to its faculty, Columbia Profs that could go elsewhere , would. Off they would go to harvard, stanford and mit, where they would be able to both produce better research and receive more accolades for it. Columbia would gradually become less attractive to talented researchers, its endowment would fall, and its ability to buy new research tools would diminsh. The downward spiral would continue until an equilibrium of talent, resources, and reward was reached.
Even if you took $$ out of this equation completely, and only subtracted prestige or reach or whatever it is that drives academics to publish, the result would be the same.
Furthermore, one could ask if the researchers at columbia are really that much better than the scientists at other universities? Controlling for everything except for the researcher’s “skill,” wouldnt the profs at arkansas ultimately come to the same conclusions, albiet maybe a little bit later or slower? (And if the answer is no, why do you think that science as a discipline is any more prone to innovation than business?)
Returns for being the best are exponentially greater than being 10th, on any scale whether it be money, power, fame, talent, or anything else. Ask Seth Godin. Are the top 40 bands really that much more talented than every other band out there? Should we mandate that no artist can sell more than 10mn records because the average band can barely sell 100? Should we let the less successful (as defined on this one scale) artists vote about it?
I don’t think so.
The one conclusion we can draw is that the system is decidedly NOT fair. But show me where in the “reality handbook” it says that life is fair. Rather than hold down others, we should strive to enlarge the pie for everyone.