Tobold's Blog
Wednesday, October 14, 2009
Fair distribution of profits

A man finds a map on which a hidden treasure is marked. He'd like to lift that treasure, but the land on which the treasure is burried belongs to somebody else. Also our treasure hunter hasn't got a shovel, and he has a bad back and doesn't feel up to digging himself. So he gets several people together: Himself, the landowner, a guy lending the shovel, and a digger. The venture is a success, and they find a treasure chest with 1,000 old gold coins. How should these gold coins be fairly distributed between the 4 people involved?

Of course this is a trick question. The 4 people represent the 4 classic pillars of capitalism: enterprise, land, capital, and labor. And in several centuries of economics no one has come up yet with a system where everybody agrees that the distribution of profits from a venture is completely fair.

Furthermore there are some trends, and changes in what is generally accepted practice, so typical distributions change over centuries and are different between countries and industries. For example landowners used to get the biggest piece of the pie, centuries ago when agriculture was still the predominant business. After the industrialization, land became less and less important, and nowadays it is usually considered just part of the capital.

The smallest part of the pie usually goes to the workers, especially if they can easily be replaced. On the other hand workers sometimes do better than the other participants when times are bad. In our treasure hunt example the digger might well have gotten paid even if the treasure chest had proven to be empty.

But while what a fair distribution is remains disputed, a lot of people can spot extremely unfair distributions. The Wall Street Journal today posted an interesting table of payments to bankers compared to revenues. Translated to our treasure hunt, if the digger had worked for one of these banks, he would have received more than half of the gold found, on average, with in one extreme case the bonus payments being 4 times higher than revenues. Notice that this are revenues, not profits, we are talking here. The average S&P 500 company this year had half a million dollar of revenue per employee. I think it is safe to say that the average employee of an S&P 500 company didn't get paid $250,000 this year.

Now the argument of bankers is that they need these high bonus payments to attract the best talent. This first of all assumes that profits of banks are proportional to the talent of their employees, which is not undisputed. And then of course the big question is why the same would not be true for many other professions: People like surgeons or engineers certainly have good salaries, but way lower than bankers. Why would investing money need much more talent than a bypass operation or building a bridge?

But what really makes many people angry is that while bankers get so much more money than other employees, a lot of other people actually lost a lot of money to the banks. If you bought bank shares in early 2007, you probably lost most if not all of your investment. And then many banks got propped up with taxpayer money. That all looks like paying somebody else to play in a casino for you, with him keeping a good part of the winnings if he wins, and you still having to pay him a lot if he loses.

So while there is a lot to be said against the state dictating how much people should earn, I do think that both minimum wages and maximum wages have some justification as long as they aren't too restrictive, and are just designed to prevent the worst cases of excess.
Very well written. Here're my few cents:

The labor should be well payed. Very good observation that this is the guy who profits most in banks nowadays - it is the banker.

The enterprise should be well payed because he took the risk - and because we need risktakers.

Land and capital are the same nowadays. These guys don't work at all to get the treasure chest. They just happen to 'own' something that is needed.
From a pure justice point of view they don't deserve anything.

However, since our culture thinks in terms of ownership, they do get payed. Nowadays they don't get a lot for what they have, but the more they have, the more they get.

Therefore you can easily spent 200.000€ the month if you have 60mio € on your bank account
and receive a trivial 4% p.a. real interest. (CEO of Goldman Sachs got $60mio in 2007).

It's beyond hope to change this, so let focus on something else.

If the guys who own the bank pay the labor more than they earn, it's their fault. If the bank goes bankrupt (lol) they employed the wrong bankers and payed them too much. Pull stop. Their mistake.

What's really bad right now is that the public supports them if the bank goes bankrupt.

Qutoing John Kay (once again):
In today’s complex environment, there are many services we cannot do without. The electricity grid and the water supply, the transport system and the telecommunications network are all essential: even a temporary disruption causes immense economic dislocation and damage. These activities are every bit as necessary to our personal and business lives as the banking sector, and at least as interconnected.
But the need to maintain the water supply does not, and must not, establish a need to keep the water company in business. Enron failed, but the water and electricity that its subsidiaries provided continued to flow: Railtrack failed, and the trains kept running. The same continuity of operations in the face of commercial failure must be assured for payments and retail banking.
I believe that there is one very simple explanation for the difference between the pay of bankers and that of professionals like surgeons and engineers: they're closer to the pot. Like the chef who can easily eat a bit of his/her own stew, the banker will always have easy access to money. There are all sorts of objections to this gross oversimplification, but ultimately I believe that this simple fact lies at the heart of the whole matter.

Money is interesting inasmuch as it is a meta-product. Money doesn't exist. Or rather, since the late 17th century, money has been credit. That 20-euro bill in your wallet is a promise from the European Central Bank to pay you 20 euros if you present it to them. But those 20 euros are no different from the 20 euros you just gave them. And of course, the vast majority of the money in the world doesn't exist as bills of any kind: it's just credit registered with various central banks.

The implications of this are staggering at first, but ultimately completely mundane. Money doesn't exist, and our entire system is based on credit, i.e. trust. As long as that trust holds up everything works nicely, but sometimes the trust folds and then things go south. Whether we call it trust or dollars, the outcome is still the same. However, it does help explain why some people get more handsomely rewarded for their jobs than others even though they on many scales are "worth" less. The people whose jobs it is to ensure that the trust remains are the ones that are worth the most in that system.

Surgeons and engineers have other currencies too, like prestige. They earn way more prestige than almost any banker through their medical journals and publications. Very few bankers can dream of getting rich in medical prestige (I imagine).

Also, this explains why I think "maximum wages" are a bad idea in principle. We can't cap that trust scale any more than we can cap the prestige scale.

And from a purely practical point of view, capping salaries is doomed to fail. These people thrive on greed. If someone tells them they can't have more money than X, it will take them all of two minutes to find a way to circumvent that rule in ways that we would have no way of penetrating. After all, they own this particular pipeline, don't they?

Sorry for the long and incoherent post.
Oh, and what Nils said (damn me for typing so long and missing other posts in the meanwhile).
Great post Tobold.

The past year has shown us that that the speculation of financial institutions is implicitly underwritten by the public purse. Of course we should limit the ability of a small group of individuals to cream off a lion's share of the profits.

My more detailed reply can be found here:
One explanation could be that in a line of work with little or no physical goods involved, it's much easier for a good worker to scale. A brilliant surgeon might have a high success rate, but at his very best he is attending only one patient (or two, in case of transplants) at a time. Contrast this with a trader or a CEO who consistently delivers 15% return on investment. If you make $1 500 000 instead of $1 500, you might not mind paying him more as well.

That said, privatized profits and socialized losses is not how capitalism is supposed to work. If you turn the risk of losing money into an externality, then people will be reckless. A trader would be much, much more careful if he had to pay back some or all of the money he lost.
"Why would investing money need much more talent than a bypass operation or building a bridge?"

That's a great question and will be answered in a post somewhere next week.
Since banks are now even more concentrated than before, can a bankrupt still occur? I don't seem likely anymore... unless the state itself goes bang (?)

Good article, very clear! :)
"Why would investing money need much more talent than a bypass operation or building a bridge?"
That's a great question and will be answered in a post somewhere next week.

Knowing Gevlon, his answer will be that investing money is a form of PvP, where you measure yourself against the others, while building a bridge is a form of PvE, where you measure yourself against a fixed challenge.

But that only explains how we got into the mess, and is not really a justification. Because, as it turns out, science has proven that paying people much more doesn't make them more likely to outwit others.
What you could easily do is increase taxes.

Like for the first 1.000€ the month you don't pay any taxes.
For the next 1.000€ you pay 10%,
For the Euros between 8.000€ and 15.000€ you pay 60% and for everything above 15.000€ you pax 80%.
For everything above 100.000€ you pay 95%...
Something like that.

An alternative, that in my opinion is optimal, is a pure value added tax.

This tax is progressive on consumption and not on income.

This way the mother who saves money to pay for the education of their children doesn't pay taxes, but the guy who builds a swimmingpool in the garden does.

If you don't tax rents and basic food it is socially very attractive without punishing the millionaire who does have a lot of money, but doesn't use it to gain any advantages from the society (read: doesn't consume ).

It is also extremely cheap to administer. It releases the crowds of intelligent people who right now put their intellect into administration of society (wealth managers etc.) and allows them to actually be productive. Become a scientist or an engineer.
I believe that there is one very simple explanation for the difference between the pay of bankers and that of professionals like surgeons and engineers: they're closer to the pot.

What Oscar said! I agree that this is part of the explanation. Actually I don't have a complete answer (yes, that's rare :).

Most surprisingly there is not and never was a public discussion how the financial industry actually manages to earn so much money compared to other industries.

Unwillingness of the public to accept the fact that the guy in the bank is not a consultant, but a salesman, is certainly another part of it.

Actually I bet that withhin my lifetime there will be a crisis very similar to the one we just had. In contrast to now some major countries will go bust or cannot support the banks that first grew too big to fail and then became to big too safe!

I just hope I can somehow save my money when that happens :)
(On the other hand, I really don't need a lot of money to play MMORPGs..)
Finally :)

Knowing Gevlon, his answer will be that investing money is a form of PvP, where you measure yourself against the others, while building a bridge is a form of PvE, where you measure yourself against a fixed challenge.

It also missed the point completely.

We (mostly) live in a market society. People get payed if they offer something that meets a high demand and is in comparatively low supply.
Combine that with the fact that the quality of a good can usually not be judged perfectly, but rather is flawed by human incompetence and you have the explanation for why some people earn a lot and others earn little.

It sometimes is a market failure and often is just how we would like our economic system to work while also telling our children to go for the job they like instead of the one that pays the most.

If people have an incredible demand for sub-prime mortages, not because they think they are worth a lot, but because they think that other people behave (not think!) like they were worth a lot, we run into bubbles.

The fact that you have to "get up and dance as long as the music plays" is a market failure. It is a "tragedy of the commons".

It is reasonbale to dance from an individual point of view, but not from societies point of view.
Whenever you run into this kind of problem you have a "prisoners dilemma", a "market failure".

You can try to regulate it, but regulation is a weak tool and prone to misuse. You can try to change the rules of the game and this can help quite a lot. But in the end we have to acknowledge that humans are not perfect and therefore their economic systems aren't.

After all we spent 99% of our evolution playing hunters and gatherers. (No, Gevlon, not apes :)
I am very troubled when I read people suggest that "government" has any role in regulating what a person earns. I see some role in government for regulating markets, but that role is nebulous and in my mind, definitely small.

In the obvious case, government was the root cause of the trouble, not the banking institutions. The Clinton administration ushered through a law that requires--not requests, but REQUIRES--50% of all home loans underwritten by Fannie and Freddie be made to "low income" individuals. Because Fannie and Freddie are the defacto leaders in the mortgage markets their rules are the defacto rules for the entire market. No lender in the U.S. operates from under the umbrella of Freddie and Fannie as those two organizations back some 80% of the mortgages here.

There are other factors involved obviously, but over time loans were given en masse to individuals who sought to purchase homes they really had no reason even looking at. The banks sought to insulate themselves from the risk involved and securitized the loans, then selling them on the secondary market along with other bundled securities. It is these "toxic" assets that we commonly refer to when we discuss the housing bubble.

I will not make this an overly political post by mentioning key players in Congress who ushered through this requirement, but let us use common sense. If Congress passes a law requiring 50% of all home loans go to low-income individuals, just what do you think are some possible risks involved might be? An upward trend in the bankruptcy rate? An upward trend in the foreclosure rate? An upward trend in home prices (faster than the average)?

Reasonable people might look at those and say, yes, those are possible risks. And wouldn't you know, that these trends were all evident in the "housing bubble" from 1998-2008. Surprising, huh? Not to many.

Government has a role, unfortunately politics gets in the way all to often of common sense. That "slippery slope" argument is not taken seriously enough and too many people do not think about the possible long term consequences for decisions they make.
I am very troubled when I read people suggest that "government" has any role in regulating what a person earns.

Does government have a role in regulating how you and I interact? You'd probably say no to that too. But what if that interaction consisted of you killing me with an axe? Suddenly government would have a role to play in our interaction, because it went beyond acceptable limits.

All I say is that such limits exist for wages as well, both as upper and as lower limit. In between those limits, let the markets decide how much a person earns exactly.

All I say is that such limits exist for wages as well, both as upper and as lower limit. In between those limits, let the markets decide how much a person earns exactly.

While I absolutely support what you want to accomplish, the tool of just regulating the the wages is not thought through IMO.

Consider Blizzard wants to fight inflation and increases the auction house fee to 50%.

A lot of people would just trade outside of the auction house. If you increase it to 200% people might start to trade symbols in the AH that lets the other person know what they have to offer!

Regulation is difficult - in MMOs and in real life. Just like in MMOs, people in real life also optimize the fun out of it!

The most direct apporach often isn't the most intelligent one.

If anybody still wonders why MMO blogs like to post on the real world so often. Well.. it's all a game - this one is just more hardcore. No joke - I mean it.
"Does government have a role in regulating how you and I interact? You'd probably say no to that too. But what if that interaction consisted of you killing me with an axe? Suddenly government would have a role to play in our interaction, because it went beyond acceptable limits.

All I say is that such limits exist for wages as well, both as upper and as lower limit. In between those limits, let the markets decide how much a person earns exactly."

How you and I interact? That depends? If the interaction is me stabbing you in the eye with a knife, then yes, obviously they do :) If by interaction you mean do they have a role in controlling how we communicate, then not only no, but hell no they do not. Government, as constituted in the U.S. is meant to be small and its main purpose is for the national security and to speak as one voice for the country. After all, you can't very well have 50 states conducting foreign policy, can we?

For the most part, we American's do not believe as many Europeans believe in regards to personal property, speech, and religion. And it wasn't until the 1930's where the role of the national government began to change. How far government should go in regulating markets, is a topic that can be immensely complicated, yet simplistic at the same time. Certainly not something I think can be given a fair shake here.

But suffice to say that Government should always seek the very least regulation, and should always error on the side of staying out of peoples way. After all, the government is our servant, not the other way around. We do not want a government that controls life, so much as we want a government that provides certain, limited, functions.
You mention talent, and allude to labour quality. There is no real objective measure of the "talent" of so-called executives. Replace them with less expensive people, and I bet you the bank would fair just as well. Often, executives take credit for profits that would result anyway from the market situation and the bank's existing clientele. Hell, executives even think they deserve bonuses when they do poorly. Nortel's brass even had the arrogance to plead as such to the Canadian government. So bonus-taking in tough times, where pensions of others are at stake, amounts to nothing less than thievery.

Another quick method to million dollar bonuses is off the backs of the other workers -- cutting costs by lay-offs and/or salary claw-backs. This is shameful and poor leadership in my opionion, yet is very commonplace especially in America where people seem to respect wealth itself more than integrity.

If you ask me, executives should get a bonus over a multi-year period, so as to better establish the earning of the rewards they are quick to lay claim to. And performance in bad times? Show some leadership and tighten your belt like everyone else.
I am very troubled when I read people suggest that "government" has any role in regulating what a person earns.

If we take this principle at face value, then you imply anarchy. Since without government, we would have no laws, no regulations, nor enforcement of them. But I am guessing you don't really mean that, and are instead espousing the usual "paying taxes is socialism" kind of rhetorical fear that handicaps many capitalists.

So let us not use the word government but instead choose a term like "authoritative body", which could be comprised entirely of capitalists themselves. When we apply the idea of a neutral overseer to business relationships, it is with the intent to establish a fair-playing field so the players are not exploited, fooled, abused, or scammed.

In the case of Tobold's example, the rules for treasure hunting would already be written and no one could take advantage of the others involved. Clear at the outset, and able to be resorted to if a dispute over earnings arises.
I think if the government has helped the company in any way all bonuses should be stopped until they are paid back in full.

This would do two things. One it would get the tax payers money back. Two it would make the executives only take money as a very last resort.

The super high bonuses are due to the fact that the people getting them are also the ones that decide who gets them. Almost everyone has an elevated sense of self worth. They all think that they are actually worth something to the company. When in actuality most of them could be replaced without consequence.
People having better lives has nothing to do with income inequality. No government, or any organization or person, should care whatsoever about income inequality, it has nothing to do with the lives of the poor getting better.

It seems that your argument is directed against the role of the federal government, which is distinct from state government.

While the federal government in the US may have limited powers, the powers of state governments are much more expansive in the domestic sphere(per West Coast Hotel Co. v. Parrish), and may well include regulation of minimum/maximum wages.
When they open the chest the gold will automatically be split between them, and the players will also receive any party loot (tokens, etc.). Then players can roll on the rest of the items in the chest according to their current class and spec. For example, the banker should roll "need" on any banking items that dropped and that were an upgrade.

The real tricky issue (which you kind of skirt around) is whether, for example, the shovelowner could roll need on a treasure hunter item for an alt. Because sometimes people say and do that and then you see it up on the AH like twenty minutes later, and that's not cool.
Something to keep in mind is the availability of resources involved. There is only 1 person who owns the land that contains the treasure. There is only 1 person who knows where the treasure is buried. There are many people with a shovel, and probably many more who are able to dig the hole. The person who owns the map has the ability to haggle with people who have shovels and dig holes. If one person offers to dig for 25% of the treasure, somebody else could be found for a cheaper cut.
I'd like to thank all of you foreigners for funding the ‘rescue’ of the US banking system so that no one had to bear any unpleasant consequences like losing their bonus.

Truly every penny of TARP was borrowed (or monetized), funded in large part by foreign gov'ts buying US debt. Debt, BTW, that is near-impossible for the US to actually repay (especially since there is no intention to do any such thing). But since the US dollar is the most ubiquitous reserve currency, what major creditor will attack its value by dumping their reserves?

So thanks for supporting my first-world lifestyle by propping up my country’s currency.

Roll the presses!
Many of you seem to be missing the point entirely. Lets say for the sake of the argument that government does have the "right" to determine how much a person makes, and passes a law that says no person shall make more than $1 Million dollars per year. Is that not an unlawful taking? Do you not see the constitutional implications of that? Philosophically, do you not see the danger in that? Government owns you, and by extension owns the fruit of your labor.

It gets even worse however. It's a slippery slope. If government can control how much you make, can you not also, by extension, say that no person can have more than 1 car? Or more than one TV? Or more than one home? It's the same principle as used to limit the salary an individual can earn.

The Constitution does not GIVE us any rights. We have all our rights by the very fact that we are living, breathing individuals. The Constitution instead limits government, and lays out some specific rights that the framers felt needed to be spelled out specifically and that Government needed to protect.

I am aghast at the sentiments I am reading here.
This is a tough one. On the one hand investment bankers are paid to game the system (mortgage backed securities, high speed transactions are the new FotM), but on the other hand, such activities fuel the overall economy's growth.

I don't neccesarily think it's a matter of regulating pay for some of these folks (I can't believe I'm saying this) but regulating their risky behavior and questionable trading practices, which can lead to disastrous consequences for the overall economy since we've discovered the economy and these institutions are intrinsically linked at this point.

Regulating their trading practices should have a side effect of naturally restricting the salaries and bonuses investment banks give out, since without their risky money making schemes, which may make them a lot of money in the short term, their revenue would probably shrink to more modest levels. Now I know some people might say it doesn't matter how much revenue these institutions are capable of making, they will still pay out these ridiculous bonuses; but such institutions won't be in business very long.

This leads to the natural conundrum of: given more regulation, which could lead to lower revenue, will these investment firms finally be able to change the way they compensate their workers?

Either way, increased regulation would probably mean the economy will grow at a slower rate, but at least we should see less bubble conditions. Of course this also depends on the effectiveness of said regulation. This could easily turn into a back in forth battle similar to the one plaguing the computer security industry. The security experts (regulators) plug a security vulnerability while the hackers find the next vulnerability to exploit. It's a neverending cycle.
Enterprise, labor, land and capital, hm? Well, I disagree a little with Nils on labor. He's the only one not contributing anything other than himself. I agree that Land and Capital are essentially the same thing. The reason we support private property is because it means that people can benefit from effective risks they took for a long time afterwards, if they were successful enough.

But I think a good way of looking at enterprise is not by considering them to be "the guy who happened to find the treasure map". Instead, look at the post you made yesterday about how the act of organizing a raid is in itself a pretty hardcore thing. Similarly, Enterprise is the one organizing the whole deal, and regardless of Land and Capital sharing some of the risk, if the venture fails, he's stuck taking most of the blame.

What if you looked at it in WoW terms? Enterprise is the guy who forms a raiding guild. Capital might be a guy who plays the AH, and supplies the guild with all the consumables for runs. Landowner might be a guy who has the key to the instance. And Labor would be all the guildies who actually run the instance.

One might point out that all parties get about the same payoff (in gear and fun) for success in the raid, and that seems to work. But look at how few people bother to run raiding guilds. And it's pretty rare that a single person (even a rich player) supplies all the consumables for a guild. Usually guildies are expected to supply their own "capital".
Great article tobold. I can give you some insight from my experience.

What they are really paying you for is your talent and your reputation. When you are working with telephone sized numbers of money you need someone you can trust. Clients and firms will pay you heavily for your

1) knowledge: most bankers/investment bankers have bachelor degrees

2) reputation: you cannot have ANYTHING on your record showing misappropriate usage of funds, robbery or any type of felony.

3) in some cases you need something called a Series 7. It is the key to most kingdoms in finance. It is a brutal test and I feel bad for the kids that are taking it now. I passed it back in 1997 and wouldn't want to face it again.

With everything else being equal these banks are paying heavily for top talent. Because they have competition like everyone else. If Bank B is making more money for their clients than Bank A, people will go where the money is. Therefore they will lose business and not afford to pay top talent.

Banks give many of incentives to employees for hitting certain numbers. They also give customers certain incentives for investing certain amounts or keeping it in longer. It's a business like everything else and needs customer funds to thrive. They need sharp minds to make this all work.

I neither condone or make excuses for some of the shady practices that are done in finance. Legalized gambling is what I have always called it. You have to know when to walk away and know when to run.
+5 DKP to Boatorious for making us laugh!

And @Inktomi... I agree with you that your colleagues (and you) can deserve the big paychecks based on reputation. But the other stuff doesn't really constitute a great yardstick. I mean, non-murdering, non-thieving university educated people who can take a test aren't really the precious diamonds you make them out to be, are they?

But, yes, reputation is huge here. Many of these people really do deserve those unimaginable paychecks. There is a common misperception that you can kick out some of these superstar executives and traders and replace them with someone at one hundredth of the price. But the reason that won't work is that the purpose of all corporations is to amalgamate trust (to borrow a term from my previous post). This is a seriously intangible asset, and it doesn't lend itself to straightforward quantification. But what is clear is that the superstar exec adds perceived value to the company, i.e. adds to its share price. And with companies valued in the hundreds of billions of dollars then paying a billion (say) to some little guy that adds ten percent to that perceived value all of a sudden makes perfect sense.

You and I won't add to the perceived value of these companies, we'll reduce it immensely. Not because we're not competent (although I'm not: perish the thought!) but because we don't possess that trust.

So give them their money, let them wade in it. It sucks that other people make sick kinds of much while I only make much, but ultimately: are you happy? If you can give a good answer to that question, then...
@ Oscar:
What you say is true. But you do realise that it is corruption that you describe, do you?

As I said before: The problem is the incapability of humans to correctly judge some assets, like that of a potential CEO.

Therefore they do not employ the one that is most competent (they don't know how to figure that out), but the one they trust the most. That's why networking is so important if you ever want to earn millions.
Somebody once said:
In the world of mathematics and formal logic, there are two modes of proof: deduction and induction. In economics, as in the other social sciences, we have three modes of proof: proof by induction, proof by deduction and proof by repeated assertion.

CEO salaries are the product of repeated assertion.

Combine that with the fact that a big salary for the CEO doesn't hurt the company, because there's only one and that he has a lot of influence in the company. Consider that the salary of your CEO is a sign for the public that your company is very profitable! Consider that you might be the next CEO and would like to earn a lot. Consider that the new CEO wouldn't like you if you said something against his high salary before he became CEO.

When it comes to bankers (labor), the underlying question is different: How does it come that the financial industry earns so much money? (Implicit government guarantees are one part of the explanation.)

This is the real problem! - not the fact they distribute it among the labor. That's the dream of every guy on the left of the political spectrum.
Again, you make a very good point Nils.

However, I definitely disagree that this is corruption. It's market forces. The market value of a public corporation is not determined by its board of directors or management group. It is determined by the market itself; the shareholders, brokers, analysts etc.

I agree that the "talent pool" is small even in the biggest market, and it is clear that there is a lot of nepotism of various sorts going on. But corruption in the technical, legal, sense it is not.

Ironically, the immediately obvious way of rewarding executives in this market-romantic world was also the one chosen by most boards of directors and management groups when they employed their superstars: pay them in shares and stock options. If the market trusts the team enough they will be handsomely rewarded and if they fail they get nothing. Of course, we all know how that worked out...
Of course, we all know how that worked out...

Yes, we do ;)
There's actually a simple rule for performance-oriented compensation:

Either you make it perfect or you skip it altogether.

If performance-oriented compensation isn't perfect, people will misuse it! Especially smart, testosterone-driven people who are 100% certain that their compensation in a market economy has to mirror their value for society! (Not because they thought it through in detail, but because that's how it always is - isn't it?)

If the CEO is rewarded for raising stock prices, he will make the shares go up. Since the public doesn't have insider knowledge of the company, there are many ways to make shares go up that actually hurt the companay in the long run or at least doesn't help the company.

It's really a general rule:
If you pay somebody for something be prepared that he will try to achieve exactly that.
If you pay people to be in office for 40 hours the week be prepared that they will do exactly that - and not much more.

If you pay people to be in public places and pretend that they clean them up, be prepared that they will do exactly that.

Therefore we don't pay our doctors any performance-oriented compensation.

Trust and public recognition are also quite good at directing people in a driection which they know is the right one. Traditionally, the human race evolved in small 'settlements' - or families that used this mechanism.

Static compensation is not as good as perfect performance-oriented compensation, but it is much better than imperfect performance-oriented compensation, because the alternative, trust, is very effective, too.
Sometimes, very rarely, an argument ends with agreement. In a way, it is a good conclusion. But leaving a conversation like that I always feel a bit... empty. Nothing left to talk about? No disagreement? Bo-ring! I suffer from post-argumentative stress disorder.

Thanks Nils for your very well thought out points!
Congrats tobold, you have officially turned your blog into the Financial Times/Wall Street Journal. I appreciate the change up from the normal faire. Heres my $5 bucks on the matters at hand.

Why five bucks? Because I personally think my opinion and experience is worth more than .02 cents, thank you.

Which brings me to stratification, the hierarchy of which the business world is built upon. Basically people are rewarded the most money for doing the most important jobs.

Doctors are not rewarded for performance but are muy importante when your sick, right? It is upon many years of schooling that they can COMMAND high fees whenever your in their office. Same with lawyers and Indian chiefs.

Accountability: Keep in mind that every Doctor, Lawyer, Banker, Indian Chief and CEO is ultimately accountable to someone for something. Whether its shareholders, clients or patients they depend on someone else for survival. It is just their testosterone driven-ness along with other elements attributed from society that put you on one side of the desk and them on the other.


You are not a (insert high paying career here) because you chose not to be a (repeat).

One of the main resources in a capitalistic society is entrepreneurial ability. You have the right to start your own software business and make your own mmo and become the next Blizzard.

Are you done laughing? Ok, you just chose your path. If you choose to work a 40 hour workweek and not uphold your right to entrepreneurial ability then that is exactly all you want to do. I think you could of made the wow-killer.

Big Wall Street Bonuses: Unfortunately most firms have contracts that require certain compensation for performance. If you have a contract that states that if you make X amount of dollars in Y amount of time you will be paid Z. And if not you have a right to sue. No one wants that, it will ruin their reputation and end up paying hefty legal fees throughout the process.

CEO's: they are ultimately responsible for everything that happens withing the company. On one side you are seeing a bloated salary, huge stock options and a golden parachute. But look at the downside. Getting fired from your position and/or if you are an owner you usually go down with the ship and end up losing EVERYTHING.

The worst case scenario for someone losing a 40 hour a week job is what? Benefits, salary and the ability to claim unemployment which in some cases is more than their salary.

Trying being a CEO and switching over to unemployment. HA!

Finance: for the same reason why people play scratch offs, lotto and powerball. You are just trying to get something without working for it. If they give it to you then they are worth it, right?

If you give me five bucks and I give you back eight your going to cry?
But Heaven's forbid I give you back less than eight tomorrow, you will not give me five ever again.

Trust: it's not just everything, it's the only thing.

You play (insert your) game because you trust that you will have fun.

You read your favorite author for that same reason. If they just happen to write a boring book then you might read the next one just on trust alone. But if the boredom continues you will find another author and buy less of his books.

Money: No, it's not everything. But try to turn on your computer and read this post without it. Maybe you might get everything for free, who knows. I know I don't.

On top talent that firms pay big bucks for: Everyone is one in their own capacity. The difference between those suckers that can pass a test and the ones who can't was the ambition, drive and belief that they were worth it.

The lawyers, doctors, ceo's and even indian chiefs also know it. And you will pay for it because that is what they will have you believe.

And if you believe your opinion is worth five bucks, then it is.
CEO's: they are ultimately responsible for everything that happens withing the company. On one side you are seeing a bloated salary, huge stock options and a golden parachute. But look at the downside. Getting fired from your position and/or if you are an owner you usually go down with the ship and end up losing EVERYTHING.

Some of what you write is correct, but some of it is not. Just picking this one:

The CEO is not the owner. He doesn't loose much if the company goes down, exept for his honor. It's called limited liability and is one of the great innovations to encourage entrepreneurs.

It's also not unusual that CEOs continue to work in management positions after their company went bust and continue to earn a hell of a lot of money (compared to most people). There are good reasons for this; but fairness is none of them.
@Oscar and Nils: thanks for the interesting read! I'd just like to add a link to a little video that makes a case against pay based on performance. It uses some interesting empirical evidence I thought you might find interesting.
I was think in terms of a Sole proprietorship or an S corp.

Sorry and thank you for the point out.
Some very good points have been raised here. However I think JFK put it best when he put this question to the American people: "Ask not what your country can do for you, but what you can do for your country."

Rampant greed and a soft-touch administration also contributed the previous years' fiscal woes. When governments cannot or do not step in to regulate various aspects of society (such as interactions, or the economy) people have a tendency to start abusing the system. If the government didn't regulate social interactions there would be nothing stopping me from putting an axe to your head (to use Tobold's colourful example).

Likewise, without regulation, there is no disincentive for banks to take our money, lose it, take the governments money, and spend it on incredibly irresponsible bonuses for their executives. As Tobold described, a fair market economy will sort out general salaries, however at either end of the spectrum it is up to the law-makers to set down the limits of minimum and maximum wages.
Unfortunately, there's a very basic problem with minimum wages, at least. If you force companies to pay a certain minimum wage, then any job that management considers "not worth minimum wage" will either A. be covered by requiring another employee to assume those duties (i.e., making highly-paid executive secretaries take their turn staffing the receptionist desk) or B. be offshored to a country that doesn't have that sort of restriction (i.e., telephone tech support). Both of these phenomena lead to an increase in unemployment, which means that, while those who are employed are guaranteed a certain minimum standard of living, there end up being more people who have no standard of living at all.

This is very basic economics, yet politicians continue to ignore it while pandering for votes....

Australia has had a long tradition of state and national (federal) minimum wages - called 'award rates'. These are industry and job-specific. It basically means that if you are a waiter, and work in Australia, you cannot be paid less than $X/hour. The award wages usually apply to casual (hourly) work and in positions where wages can be incredibly low (such as the average pay of waiters in America).

Since its a statewide/national minimum wage it doesn't dampen competition, since the cafe down the road has to pay their waiters the same as you, but you have the option to pay your staff more if you want to retain them.

Also, these jobs are (by necessity) difficult to outsource to low income earners overseas. It would be very difficult to outsource retail staff or waiters. And before you cry "But if wages went up, costs would rise, and no one would eat out or go shopping!" of course people will continue to eat out, and go shopping.

The cost of living in the 'West' or 'first world' has risen so sharply in the last generation (hell, the last decade) that paying people a pittance an hour is *not* actually helping their standard of living. It's making them work 2 40 hour/week jobs just to buy the groceries/pay bills/pay rent.
If you force companies to pay a certain minimum wage, then any job that management considers "not worth minimum wage" will either A. be covered by requiring another employee to assume those duties (i.e., making highly-paid executive secretaries take their turn staffing the receptionist desk) or B. be offshored to a country that doesn't have that sort of restriction (i.e., telephone tech support).

While that is true, it is not the whole truth.

The lowest wages are a result of the market. That is the employer asks himself two things:

1) What is the maximum I can pay for the job?

2) What I the supply and demand of labor and how much do I have to pay to get somebody to do the job? (Supply & Demand)

Question (1) is important and you described its consequences.

Question (2) is the reason that low qualified jobs earn you less and less wages nowadays.

Some blue collar jobs where oursourced in other countries (globalisation), but all blue collar jobs suffered, as a consequence. Even the one that cannot be outsourced (haircutting).

Reason is that these kinds of jobs can be done by almost anybody and therefore the supply of labor increased without an increase in demand. That decreased the price for blue collar labor; that is the wages.

I am not a supporter of minimum wages at all, I'd rather introduce a basic income. But an introduction of minimum wages (or increase of them outside Germany) will only increase unemployment a little bit, becasue of effect (2).

Most blue collar jobs that can be outsourced already have been, because the social welfare already introced an effective minimum wage that is much higher than in undeveloped/developing coutries.

The reason for the low wages is the massive supply of low qualified labor that is an effect of this outsourcing which already happened.

Charwomen don't earn so little, because the work isn't worth for us. Actually we'd probably pay quite a lot before we started to clean up the toilettes at work ourselves.
They earn so little, because the supply of this kind of labour is much higher than the demand - and everybody can do the job.

And in this situation the introduction of minimum wages doesn't produce much unemployment- if any.

JFK remembers me of Mythic asking the people to play less scenarios and more open world PvP.

This is the developers responsibility! Read Tobolds todays entry ;)

The problem with a system such as the Australian one is that it assumes that government bureaucrats, who are usually appointed officials and not directly accountable to the electorate, are more qualified to decide what is an "appropriate" wage for a given job function than the people who work in that industry. This strikes me as a grievous flaw.


The biggest problem isn't offshoring (though I'm personally getting very worried about the near-future possibilities of remotely-operated surgery devices and their implications for offshoring). The biggest problem is simply that of the job functions being eliminated and subsumed into some other already existing job. Hence modern business's obsession with multi-tasking. Having worked for far too many companies that engaged in such practices, not because they wanted to but because government regulation essentially forced them to, I'd rather let market forces decide the matter.

Then again, I'm an American and most of us inherently distrust government as a solution to anything. Our government can't even effectively run our Post Office, which is one of its very few Constitutionally-mandated tasks....
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