Jeffrey Sonnenfeld, the Lester Crown Professor of Management Practice at Yale, is the Senior Associate Dean of the Yale School of Management. He is also a member of the board of directors of TheStreet.com, which publishes this Web site. In today's House Financial Services Committee hearings, the contrite CEOs of financial institutions were drilled repeatedly by legislators over the lush payouts given to the lieutenants of these financial titans just weeks ago. Occasionally, professors hear, "If you are so smart, why aren't you rich?" To which professors covertly retort, "If you are so rich, why aren't you smart?" This false link between salary and intelligence, or creativity and intelligence, is at the heart of the debate over President Obama's bold proposal to cap the salaries of the leaders of firms receiving massive taxpayer bailouts so their companies can stay alive. Apparently many who believe that Gordon Gekko's "greed is good" mantra fear that salary caps will extinguish the presumably priceless spark of innovation in Wall Street. This, despite the tragedy that the failure of many of the brilliant new instruments has wiped out much of their presumed legacy -- along with our economy. Widespread outrage followed reports that billions of dollars in bonuses were paid to pampered fallen Wall Streeters by already beleaguered Mainstreeters across the nation. In fact, the CEO of distressed Merrill Lynch used such support for more than $1 million in office décor, $240,000 salary for his limo driver, and a rushed payment of $5 billion in bonuses to his lieutenants on the eve of its takeover by Bank of America ( BAC). His failed predecessor left a year earlier with $200 million in exit payments, while competitors paid executives $50 million and $60 million apiece in normal annual compensation, only to beg for public life support a year later.
The pay plan's backers celebrate reining in perceived excess rewards for those responsible for failing enterprises that are crashing the nation's economy. There is more than public relations at work here. They also see fairness. With Obama's plan, there will be more clear pay for performance links for executives as their earnings will now depend on their company's performance. The $500,000 ceiling on executive salaries -- currently being proposed in President Obama's plan -- can be supplemented by substantial grants of restricted stock incentives that can be cashed in once borrowed taxpayer money is returned to the government. And even this is accelerated if shareholders can vote on executive pay. This pay-for-performance match restores some of the lost logic of Wall Street riches -- which is risk. The term "risk" is bandied about so often by Wall Streeters that you'd think it was their money at risk. That used to be the case in era of 19th Century merchant bankers and even 20th Century investment bankers -- and still generally is for private equity -- where either it was the partner's money or a small group of investors. There were virtually no public companies on Wall Street until the 1980s, and now the major firms are all public. When it was their own capital at risk, the partners were entitled to large rewards on their triumphant investments. In the 1970s, half the partners of Morgan Stanley ( MS) were listed in the Social Register, certifying their common Mayflower lineage. John Mack, of Lebanese decent, would not have been on that list. In fact, only one firm, Bear Stearns, used the TITLE tile "chief executive" before the 1980s.
In the 1980s, those partners retired and were replaced by hired hands who were now agents and not principals. They'd become the managers of other people's money -- initially diverse shareholders and now at the troubled firms, the nation's taxpayers. Not only were their mutton chops, long lunches at Delmonico's, and afternoon strolls to the counting house before tea -- all long gone -- but so are the days of I-bankers risking their own money -- until this new Obama plan. Ignoring this structural change, some bankers still long for the lush good old days. The pay plan's critics rush to tortured ideological claims of government intrusion into private enterprise - despite the logic that this moral and intellectual claim was buried once these firms threw their fate into the government's arms. Employers at a firm like AIG ( AIG) -- with 80% government ownership -- surely must privately admit that they are virtually civil servants now and drop past illusions of princely lifestyles. The fair yardstick then must be the salaries then of top public officials. With President Obama earning only $400,000 annually, Vice President Joe Biden earning $221,000, House Speaker Nancy Pelosi and U.S. Chief Justice John Roberts earning a mere $217,000 with U.S. Senator s and federal judges earning far less -- the $500,000 for financiers whose companies are on the public dole looks pretty good. The deal looks even better when you add in the stock incentives' upside potential of enormous wealth for good performance.
Of course, that public sector yardstick still doesn't shatter the princely expectations of Wall Streeters. Many recall Babe Ruth's comment when he was told his salary dwarfed that of President Herbert Hoover: "I know, but I had a better year than Hoover." The critics forget that the performance based retort doesn't work here. Dick Fuld of Lehman can hardly identify with Babe Ruth's batting average. Nonetheless, some Wall Steeters also argue that the financial magnet is critical for talent attraction and retention. In this time of distress, where will they go for a better deal? Critics cite the flight of a dozen Merrill Lynch stars for Deutsche Bank ( DB) this week as proof that top talent will flow to the many higher-paying financial institutions that beckon. Sadly, these Merrill refugees are about to become salaried employees anyway. They must have missed the rest of the Deutsche Bank news this week that the bank just reported $5 billion in losses for the year and no profits in any of its business units. Furthermore, reports show pressure for pay moderation, curbing excessive compensation at all European banks, including even those few such as Barclays ( BCS) and Deutsche Bank. In fact, investment bankers in Europe have had less than half the commission structure of Wall Street with Asia far lower. It seems that Wall Street wages were already for more mismatched with global competitors than the maligned Detroit autoworkers against their global counterparts. It is true that financial services is a notoriously fluid labor market but haven't top stars already have been trying to flee sinking ships before salary caps were distressed? In fact, Greg Fleming, the president of Merrill Lynch, just left for a job a Yale University. (Surely this is not because we are not a TARP protected institution!) Perhaps there is more than commercial greed that drives brilliance. Mozart dies in poverty but few would claim that the affluent Madonna was more creative. Van Gogh hardly had the commercial triumphs of the mass production "art" of Thomas Kincaid but their creative genius did not match their bank accounts.
Hopefully, for these bankers' own interests, greed does not produce genius. When those stressed out Wall Streeters get their triple bypass surgery, they'll be trusting their lives to brilliant cardiothoracic surgeons earning a median wage of $424,000 nationally and only $516,000 if they practice in New York City. In fact, the Medtronic ( MDT) clinical specialist engineer who developed the medical devices that may be implanted toiled happily for only $70,000 with a possible bonus of $18,000! That even makes the modest pay of the finance professors who trained these financial Masters of the Universe look pretty good. Hugely successful CEOs of great firms ranging from UPS ( UPS) to Costco ( COST) love their jobs and take very modest salaries. Marketing genius Roger Enrico of Pepsi ( PEP) never took his salary as CEO, donating it to Dallas school children. Turnaround star Bill George of Medtronic regularly declined the salary increases encouraged by his board. If the fallen financiers are really so brilliant and want high rewards, they should welcome the Obama pay plan as it will reward their successes. Perhaps this is why it has earned praise from such unexpected voices as Jack Welch and CNBC's Larry Kudlow. If financiers choose to leave their institutions, they should start their own. Steve Jobs hasn't taken more than a dollar a year in salary and other founders such as Bernie Marcus of Home Depot ( HD) always took modest salaries. These leaders become multi-billionaires by stock incentives that would reward great performance much like what is offered to financier in the Obama plan. This harkens the old Smith Barney tag line "We make money the old fashioned way, we earn it." Jeffrey Sonnenfeld, the Lester Crown Professor of Management Practice at Yale, is the Senior Associate Dean of the Yale School of Management. He is also a member of the board of directors of TheStreet.com, which publishes this Web site.