The time has come for reform in executive pay, but what would the ideal solution look like?
The ideal solution for executive pay would be a self – regulating system that maintains a healthy tension between shareholder’s interest and an executive’s motivation for padding their own pockets. The ideal model for this is the Solomonic pie cutting test solution:
(1)There is one piece of pie left and two kids who want it, (2) Mom says that one kid cuts the pie and the other kid picks the piece and (3) the kid slicing the pie is incentivized to cut the pie as fairly as possible.
Another intriguing model is the baseball arbitration model:
When baseball players are arbitration eligible, (1) the player and the team each submit a salary figure to an arbitrator (2) the arbitrator picks either the player’s number or the team’s number. The player is therefore motivated to submit a reasonable number to the arbitrator in hopes that the arbitrator sides with him.
The pie cutting model is more elegant because it doesn’t require an independent third party. Ideally, the model would not cap executive pay, but simply put the executive’s pay clearly between his own desires and shareholder’s interest. And when I say clearly, I mean that there is no buffer (like a board of directors) between the two interests.
SOLUTION:
Each publicly traded company should have a $5M or 1% earnings cap, whichever is greater, on the base salary and benefit package that any employee would receive. However, in addition to the cap on base pay, each executive would also get a bonus. The executive would submit a bonus figure to the stockholders and they would vote on whether to give it to him or not. If they vote YES, he gets the requested bonus, if they vote NO, he gets no bonus.
This puts pressure on the executive to request a reasonable bonus based on his actual performance from the previous year. This would eliminate the AIG bonus situation because the executives would not have the courage to even ask for a bonus when they ran the company into the ground. This solution would eliminate executives who get overpaid when their company takes a loss.
However, this solution may not incentivize executives to meet long-term shareholder goals. As an option though, the bonus that the executives would receive, could also come in the form of 3 or 5 year vesting stock options.
Ideally, the solution would involve no government intervention or regulations. But implementing a uniform solution would require a new law, although the law would require very little active regulation.
Do you have a different solution?
Do you have a modification of the proposed solution?
What kind of behavior would the proposed solution cause? Critiques?