Tuesday, February 10, 2009

The Best Idea Yet

(Cross-posted at the Moose, TalkLeft and MyDD)

The word on the street is that the caps on executive compensation may end up getting removed from the final version of the economic stimulus package. Rather than abandon the idea altogether, James Kwak has a brilliant suggestion (h/t the Left Coaster):

Why not say that all bank compensation above a baseline amount - say, $150,000 in annual salary - has to be paid in toxic assets off the bank’s balance sheet? Instead of getting a check for $10,000, the employee would get $10,000 in toxic assets, at their current book value. A federal regulator can decide which assets to pay compensation in; if they were all fairly valued, then it wouldn’t matter which ones the regulator chose. That would get the assets off the bank’s balance sheet, and into the hands of the people responsible for putting them there - at the value that they insist they are worth. Of course, the average employee does not get to set the balance sheet value of the assets, and may not have been involved in creating or buying those particular assets. But think about the incentives: talented people will flow to the companies that are valuing their assets the most realistically (since inflated valuations translate directly into lower compensation), which will give companies the incentive to be realistic in their valuations. (Banks could inflate their nominal compensation amounts to compensate for their overvalued assets, but then they would have to take larger losses on their income statements.)

A brief digression. Years ago, I watched superstar attorney David Boies argue for federal court approval of a class-action settlement he had negotiated (for the curious, it was the Sotheby's/Christie's antitrust litigation). Normally, courts disfavor so-called "coupon settlements" because a coupon, as opposed to cash, tends to be useless to the average class member. Boies, however, believed that in this particular case, the coupons would have a significant cash value (in other words, there would be a secondary market for them) and thus the coupon settlement was in the best interests of class members.

How did Boies win the argument? Much like the idea I've quoted above, he told the judge that instead of taking his attorney's fee in cash, his law firm would accept COUPONS as part of the fee - in the same proportion that class members would be asked to accept coupons. So he was actually staking his own livelihood, not merely that of the class members, on the proposition that the coupons had value.

I cite this real-life example to illustrate that this is not just some lunatic idea off the Internet. In fact, it really does force senior management to stand behind the valuation they attach to the bank's assets, in a very real way. Maybe this will force a re-valuation of some of the assets, maybe not, who knows. But at the end of the day, this solution gets a lot of toxic assets off the books, and the marketplace will have more respect for the valuation of the assets that remain on the books - knowing that senior management is staking their own personal compensation on the proposition that the valuation is accurate.

I can say with no hesitation that this is a far better idea than anything I heard today from the folks who are actually running the Treasury.


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