Paul Krugman remarks on the need for reform in compensation schemes in the financial sector:
What’s wrong with financial-industry compensation? In a nutshell, bank executives are lavishly rewarded if they deliver big short-term profits — but aren’t correspondingly punished if they later suffer even bigger losses. This encourages excessive risk-taking: some of the men most responsible for the current crisis walked away immensely rich from the bonuses they earned in the good years, even though the high-risk strategies that led to those bonuses eventually decimated their companies, taking down a large part of the financial system in the process.
The Federal Reserve, now awakened from its Greenspan-era slumber, understands this problem — and proposes doing something about it. According to recent reports, the Fed’s board is considering imposing new rules on financial-firm compensation, requiring that banks “claw back” bonuses in the face of losses and link pay to long-term rather than short-term performance. The Fed argues that it has the authority to do this as part of its general mandate to oversee banks’ soundness.
Given the assumption that once a bank has reached a certain size it won’t be allowed to fail some sort of restriction on compensation is a necessity. I’d prefer that banks be prevented from reaching a size at which their failure would have systemic consequences but that’s a proposal that has no legs at all—neither Democrats nor Republicans seem to have any sympathy for it.
There’s a much simpler reform that would do the trick, too: limit total compensation to current year revenues less accounts receivable. I’ve got to admit I’m a radical on this subject. If I were king, I’d limit the maximum individual compensation in any company, financial sector or automaker, that has been bailed out by the federal government, to that of a GS-14.