Regulating pay: A step backwards

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With the recent economic recession many governments have taken it upon themselves to rescue private businesses, pumping them full of taxpayer money. Governments around the world have decided that it would be best to save companies that could not survive in a free market system and in so doing they have intensified the economic uncertainty in the market. Almost immediately, the government starting capping CEO pay, and regulating bonuses, to protect taxpayer’s money that should not have been there to begin with.

The problem is that without incentives to perform, a high-quality CEO will leave to a company that can afford to pay him more. If a failing business is not able to attract superior management to itself by paying more then it will most certainly continue on its path towards complete failure. The government should mind a lesson practiced regularly in the world of sports.

According to Sports Business Daily the average annual salary for a football coach in the National Football League in America was just under $3 million with only 13 coaches making less than the average. The interesting point is that of the 13 coaches that make less than the average only 1 has ever made it to the Superbowl. In college sports the story is not much different; according to the NCAA the average salary for football coaches has increased to over $1 a year and bonuses for winning a single game can reach as high as $450,000. No one would argue the fact that coaches indeed make a difference on how well a team performs, and clearly the best coaches are paid the most. The government doesn’t attempt to cap coaches’ salaries in publicly funded universities because they understand that a coach that can win will fill the stadiums and gain a profit for the University. The same is true in the world of business.

According to an article published in the Journal of Managerial Finance titled CEO Pay and Company Performance authors Kevin J. Sigler and Joseph P. Haley found, “a positive and significant connection between the pay of CEOs and the performance of their respective firms."  They further stated, “From our results it appears that CEO pay is used to align the interests of shareholders with company CEOs, reducing agency costs within the firm." Those in charge of determining CEO pay are those that have the most to lose, the shareholders. Deciding how much to pay a CEO is a simple matter of economic trade-off between compensation and expected performance.

Just as I assume the lowest paid coach will likely not have a good season, I also assume a low paid CEO will not bring in a large profit margin. Incentives to perform need not be tampered with if the government would keep out of private business. Let any company pay its CEO however much they desire, and if it doesn’t work out then let the company go under. The best way to regulate CEO pay is to allow the free market to punish and reward decisions by shareholders on the matter.