Thursday, February 05, 2009

What kind of job would you do for $500,000?

This week President Obama suggested that financial firms taking federal bailout money cap their executive pay at a half million dollars per year.

This is what economists call a price ceiling. What happens when you have a price ceiling is that prices automatically go to that level. So now that all bailed-out banks will have half-millionaire CEO’s what is the incentive to be a bank executive when you could be an executive of a less-regulated industry.

A paycheck is essentially a bribe to get you to do something you would otherwise not do. Most people would rather sleep in, take a relaxing drive to the gym, read a good book, catch up on Lost and eat out at expensive restaurants, rather than sit in a monochrome cubicle for eight hours strait.

By capping executive salaries, or any salaries for that matter, you will have the most talented executives leaving the banking industry for more lucrative careers where earning potential will not be limited.

Inversely when you can only pay an executive a mere 500 large, you get a 500k executive. Okay, let’s put that in some more scaled down terms if you actually think that $500,000 is a lot of money.

If you ran a restaurant and you were only going to pay your cook $1 per hour that he worked how good of a cook do you think you would get? Sure you would get the Wolfgang Puck of most third-world countries for that rate, but for our little example let’s assume your restaurant is somewhere in North America.

The answer is that you would get either no one willing to do the job for that amount or someone so terrible at their job that they are only worth one dollar per hour.

An executive worth only $500,000 in our society is a pretty bad executive. This would lead to a talent vacuum in the financial markets which would put them in further disarray, leading to more government intervention, regulation and socialization of our private sector. Then again, that’s probably just Obama’s master plan.