Oct 23 2009, 1:13PM
The Goldman Sachs Bonuses: II
Here are two questions about the bonuses that I did not discuss in my blog yesterday:
1. Could the bonuses be compensating for the risks of a career in finance?
2. Shouldn't Goldman want to limit the bonuses paid its employees?
1. Consider actors' careers. A handful of actors have huge incomes. Most actors have such meager incomes that they abandon acting as a career. The lucky handful are like lottery winners. The only way you can motivate people to buy a lottery ticket is to have a big jackpot for the winner of the lottery. Similarly, the only way you can motivate people to attempt a career in acting is to provide a jackpot for the tiny handful of aspirants who succeed.
Could finance be the same? It is, after all, a risky business. The question is what happens to employees of Goldman Sachs or other financial firms if they engineer or approve a very risky deal, and the deal is a flop. Are they exiled from the industry? Do they end up as waiters? If so, the huge incomes of successful financiers would be justified as compensation for the risk of failure. My impression is that the failed traders, deal makers, etc., do not end up as waiters, or in other relatively impecunious jobs (I say "relatively" because waiters in elite restaurants are well paid by ordinary standards). Their training and experience equip them for a variety of good jobs in the financial industry. They can look forward to a soft landing, and therefore it is unlikely that the high incomes of the most successful financiers are compensation for the risk of failure.
It is true that anyone who is risk averse will seek compensation for taking risks, but the people who gravitate to risky occupations are unlikely to be risk averse. Put differently, as long as there is an ample supply of risk preferrers, an employer will not have to pay a premium based on risk aversion. And, as I have just suggested, the career risks in being a trader or deal maker for a major financial firms like Goldman Sachs are probably very small.
2. A "monopsony" is the converse of a monopoly. A monopolist reduces output in order to push price above the competitive level. A monopsonist reduces his purchase of an input in order to drive the price of the input below the competitive level. If a firm faces an upward-sloping supply curve--meaning that the more it buys, the higher the prices it must pay--then if it buys less, thus moving down the supply curve, it will pay lower prices for its inputs. Suppose the input in question is labor. If the relevant labor market is competitive, monopsony won't be feasible; workers offered a lower than market wage will quit and work elsewhere. But suppose all the firms in an industry conspire to reduce their hiring; then wages will fall because the affected workers will not have good alternatives.
So why don't financial firms welcome pay caps, or, in Goldman's case, since it isn't subject to the caps, voluntarily compress the compensation they pay? There are three answers. The first is that if the firm does so, its best employees will quit and work elsewhere. This is not as compelling an answer as it seems, since demand for financiers has fallen and, more important, because Goldman Sachs is regarded as the world's premier financial company and (therefore) immensely profitable, so it is unlikely to hemorrhage employees merely by cutting bonuses; and if it loses some, it should be able to replace them.
The second answer, which is related, is that without industry-wide pay caps, a reduction in wages is not an equilibrium; Goldman Sachs might be able to get away with limiting its employees' compensation in the short run, but in the long run it would lose superior employees to competitors. It might therefore flaunt its huge bonuses in the hope that this would power the movement for industry-wide pay caps.
But third (and a compelling reason for doubting that Goldman wants industry-wide pay caps), we know that the top managers of large corporations are not perfect agents of the shareholders--the nominal owners of the corporation. A pay cap might be in the interest of shareholders, but it would not be in the interest of the top managers, since it is they who would be subject to the cap, either alone or together with traders and other subordinate employees.
(Photo: Getty Images/Mario Tama)
Comments (3)
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Richard A. Posner
The bonuses Goldman paid are potentially based on a traditional cut of the earnings generated by one's activity. Perhaps what's really objectionable here is that the company was able to make and keep so much private gain by consequence of public expenditure.
There are really only three choices for Goldman.
1. Give the Profit to the Government - Hey, thanks for that bailout, we could have never have had a good year without it, here, we insist, please accept 90% of this year's net as a token of our sincere appreciation and gratitude.
or
2. Keep The Money, and
2A. Distribute it to employees and shareholders as typical in our corporate culture, or
2B. Cap bonuses and salaries for public relations reasons, and distribute the "excess" to shareholders.
Clearly, they chose 2 (probably easy), and then 2A (perhaps less easy).
But, as a guess to their reasoning, how would it have affected employees' morale to not be compensated as usual and to instead see most of the profits from their work siphoned away into the corporate trough. What is more objectionable - employees getting paid their usual commission - or shareholders receiving an unexpected above-normal cut of the total yield in their dividends?
Perhaps it would have had better politics "optics" with the public, but I think the shareholder windfall at the expense of normal employee-compensation practices would have been a worse choice for the company.
What wrenching decisions... oh, the burdens of megaprofits...
The Goldman Sachs Group, Inc. received a $10B investment from the TARP funds on 10/28/2008. The group repayed the investment and premium of $11.1B on 7/22/2009 per the contract with the US Treasury.
I would suggest Goldman encourage the employees to buy the corporation and de-list from the NYSE. Then we would not worry what they do with their profits, because they would not be public knowledge.
http://www.financialstability.gov/docs/transaction-reports/transactions-report_10232009.pdf
If the relevant labor market is competitive, monopsony won't be feasible; workers offered a lower than market wage will quit and work elsewhere.
More precisely, if there is low cross-elasticity of demand for jobs, then workers offered a lower wage will quit and work elsewhere. Some large tech firms in the Bay Area have managed to offer lower wages in exchange for less tangible perqs that can more generally be attributed to firm culture.
Similarly, on the client side it's the firms that are well-differentiated and in demand that can pass increased labor costs on to clients better because their supply being more inelastic relative to their competitors.
The combined effects seem at least partly responsible for the approximately pareto-distributed equilibrium observable in these types of markets. One suspects that the stickiness of the social networks that constitute these markets has much to do with the dynamics.