It has been proven time and time again that in order to succeed firms need to be flexible and adaptable. One of the most effective tools available has been bonuses. If you work hard you get a reward, if not you don’t. If times are good you get a big ….

Granted, there may not be a person who was in on each phase of my story. However, there are plenty who were in on more than three phases.

My two cents worth is that they should be treated like insolvent firms and have an administrator appointed by a bankruptcy court (with some rules for removing the administrator once the firm is solvent). The incentive to accept a TARP handout would certainly disappear once some “strings” are attached.

Possibly, but the problem is that TARP funds have not gone, and are still not going, to banks that are in particular financial distress, but to banks that are politically connected or whose rescue serves some policy end unrelated to the soundness of that particular bank. It’s common knowledge that many banks were compelled to accept bailout money to avoid harming the reputations of those banks that got TARP funds because they actually needed them. So in general, no, I would say that bundling TARP funds with this type of government oversight is likely to make a bad situation worse.

It would have better, of course, to let insolvent financial institutions actually go bankrupt, and have a real bankruptcy judge make the kinds of decisions you’re describing!

So, given the market will not have the opportunity to “discipline” these poor incentive schemes shouldn’t you be arguing that these firms are insolvent and thus NO bonuses should be paid (as would likely be the case in the free market if these firms went bankrupt)? A bankruptcy administrator or trustee must make administrative decisions such as these all the time – would it be better if the government appointed a bankruptcy trustee to each firm that receives bailout funds?

P.S. This is no way suggests that the government should legislate out of existence a whole class of compensation

Although the market was down, we don’t know how any individual broker’s portfolios performed relative to the market performance. As I tried to explain to one of my classes last week when this issue broke, if my portfolio went down only 30% when the market was down 40% for the year, then my portfolio manager may have done exceptionally well for me and may deserve a bonus–particularly if that bonus was contractually tied to performance relative to the market.

Many incentive systems are not based (exclusively at least) on absolute performance that may be more sensitive to general uncertainties, but on relative performance that is intended to isolate (insofar as possible) the idiosyncratic performance of the worker. How the market as a whole did is much less relevant in this situation than the Obama administration and the press seem to understand (or are willing to admit). As Peter suggests above, it’s an aggregation problem…especially when we don’t have details about the who and why of the individual bonuses.

I agree.

@ Peter

1. No, it would not.

2. It is better to rely on market incentives.

3. My argument is that the banks made record profits by selling lemons and now they are insolvent (literally not technically). The Dow also returned its worst performance since the Great Depression. Given these facts, the public (and President Obama) is quite justified in thinking something fishy is going on if general managers can get rewarded for non- (or pseudo) performance in the recent past. But you are right, he can’t possibly know the details. However, if it quacks like a duck…

P.S. When a corporation accepts a taxpayer-funded bailout in lieu of the discipline of the market then the government DOES get a say in organizational architectures.

1. Would an industry-wide ban on bonus payments, in the middle of the compensation period, regardless of (a) how many (if any) “lemons” a particular employee sold, (b) what other elements are in the employee’s compensation package, (c) what decision rights the employee holds over what is sold, how products are priced, marketed, rated, etc., and (d) whether the employee’s firm received public funds, be an appropriate policy response to the situation you describe?

2. Getting incentives right is no easy task, as I tried to suggest above. All forms of compensation have benefits and costs that have to be balanced carefully, at the margin. Firms often make mistakes, and their performance tends to suffer as a result. If auto dealerships were to employ a system, by design or by accident, that gives salespeople incentives to push lemons, is it better to rely on market discipline to make them mend their ways (as Anthony’s comment suggests), or to ban an entire class of performance incentives?

Back to the case at hand: What could President Obama possibly know about the details of the bonus payments he now attacks? Who exactly got them and under what circumstances? What are the relevant pay-for-performance sensitivities? He hasn’t the faintest idea. He is simply exploiting public sentiment against “Greedy Wall Streeters.” More generally, do we really want the Federal government deciding what organizational architectures are OK?