Tuesday, August 11, 2009

More Conservative Pundit Economics

As I have previously observed, conservative pundits seem to think they can fob us off with columns that contain the most elementary errors in economic analysis. I don't know whether they are fools, or whether they assume that we are fools.

The latest absurd column is from Amity Shales ("senior fellow in economic history at the Council on Foreign Relations"). Shales argues against pending legislative proposals that would regulate corporate executive pay. She claims that corporate pay shouldn't be any more subject to regulation than the pay of baseball players. Baseball players can make piles of money -- sometimes even when their team is doing badly as a whole -- and no one seems to mind. So, Shales argues, no one should mind when a corporate executive makes a pile of money, even if the company as a whole is doing badly.

Oh, for heaven's sake. This is an absurd analogy. A baseball player's salary is set in an arms-length negotiation with the team's management, and the team has every incentive to pay the player as little as possible. Most baseball teams are closely held (i.e., owned by one person or a small group), and the owners therefore have direct, personal, substantial incentives to hold salaries down as much as possible. So when a player gets what seems like a ridiculous salary (to someone earning ordinary amounts), we know at least that that salary was set in a real negotiation.

Corporate executive pay is different. It is subject to the vast "agency problem" that exists when ownership and control are separated. Public corporations are owned by huge numbers of shareholders, each of whom typically has only a small interest in the overall corporation. If the CEO puts his hand in the cookie jar and pays himself $10 million more than he really deserves, each shareholder might lose only a dollar or two. So the owners don't have the right incentives. It's not worth kicking up a big fuss to save yourself a dollar.

Of course, CEO pay has to be approved by a company's board of directors, and the directors of most public companies have delegated this task to a compensation committee that is supposed to protect the shareholders' interests. Probably this works well at some companies and not so well at others.

The point here is not that the legislative proposals for regulating corporate pay are a good idea. Maybe they are and maybe they aren't. Maybe the market for executive pay works well enough, despite the important agency problem, that regulating it would do more harm than good. Maybe it doesn't and we need legal regulation. I don't know. (For a good CRS study on the question, see here.)

But what I do know is that comparing executive pay to baseball players' pay while ignoring the agency problem that attaches to the former is a cheap and irresponsible debating trick. It's not an appropriate analogy.

Sheesh. First conservative pundits think we don't know about externalities and now they think we don't know about agency costs. And they bill themselves as economic experts!

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