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    Why Bankers Make So Much Money

    By Michael Wolraich on Fri, 10/23/2009 - 12:19pm | Politics, Business

    When I worked for a software company, a fellow computer programmer once lamented that the salespeople earned so much more than the coders, despite the fact that the coders were generally better educated, more intelligent, and more essential to the company's core value: its products. The reason for the disparity is straightforward. Salespeople are closer to the money. It is very difficult for executives to perceive the value good programmers, who represent cogs somewhere deep in the machine, but the value of good salespeople is obvious from their sales numbers. For instance, it is easy to justify paying $200,000 in salary and bonus to a salesperson who makes sales worth $500,000 in annual profits.

    My colleague's dismay exhibited the wide gap between "merit value" and "market value." Merit value is an amorphous sense of the worth of an employee based on capability, education, seniority, and hard work. Market value is the perceived monetary worth of an employee. Our economy is primarily based on market value. Insofar, as we reward merit value, it is because of cultural reasons and a loose, indirect relationship between merit value and market value: people generally perceive monetary value in the meritorious qualities of capability, education, seniority, and hard work. Yet while this indirect relationship may hold true within a particular field, it varies widely between fields. Thus, the most capable coders are likely be the top paid programmers, but they are unlikely to be paid as well as the most capable salespeople.

    The principle of market value infuses even those industries that we might like to think of as merit-based. Book publishers, for instance, pay the highest advances to the authors they believe will most likely generate the highest sales, which is why prominent writers of trashy romances and conservative screeds can get high advances, while brilliant academic historians rarely receive any. Even within the academy, tenure for the sciences is primarily awarded to the professors who can capture the most grant money.

    Which brings us to bankers. Many investment bankers are intelligent, hard-working, and capable, but like any other employee, those qualities are only indirectly tied to their compensation packages. Bankers make the big bucks because they are extremely close to a lot of money. When an employee conducts transactions worth tens or even hundreds of millions of dollars, then small differences in ability can make a difference of millions of dollars for the employer in a very obvious way. For that reason, it is an easy decision for banking executives to pay massive salaries and bonuses for the top talent. Such monetary considerations travel all the way up to the CEOs, who are perceived to make the largest difference to a bank's profitability.

    Of course, the cronyism and short-term thinking prevalent in banking is certainly a related problem, but it is a market value problem of mistaken perception, not a merit value problem. Yet what seems to drive the rage of the anti-Wall Street crowd is not market inefficiency but the myth of merit value: bankers getting compensated far more than they deserve for their work. But our system is based on market value, and while this system is not ideal, we have not been able to invent a better one. The only known alternative to market value is some kind of human judgment of merit. Such judgment inevitably devolves into political bias, which is even less related to merit than market value. From nation-sized communist systems to department-sized bureaucracies, human judgments too often result in higher pay for the most loyal and sycophantic employees, not the most capable.

    Because our system relies on market value, the government's current plan to cap executive salaries at companies that received bailouts will do nothing to address income disparities between the rich and poor. It will not affect banks that did not receive bailouts or all the other industries, from law to medicine to Hollywood to all manner of business, where compensation of certain employees towers above that of everyone else in the country. And within a year or two, the government's bailout leverage will dwindle, and it will be back to business as usual among the bankers as well.

    Though it may seem like a paradox, if we really want to address income disparity, we need to be honest with ourselves and firmly reject the myth of merit value. That is because as much as merit value appeals to capitalism's critics, the myth of merit value is even more prevalent among the pro-market anti-tax crowd. Conservatives tend to fiercely oppose taxes on the grounds that rich moneymakers deserve their wealth due to their capabilities and work ethics. If we abandon the notion that people deserve all the money that they earn and are instead simply beneficiaries of somewhat arbitrary market forces, then implementing higher taxes on top income brackets will be less controversial. The rich people who are most open to high taxes tend to treat their wealth as a kind of lucky windfall rather than a well-deserved fortune. We need to encourage this attitude towards wealth and stop pretending that financial compensation must be something that it cannot be.

    Or for a more cynical take, see Willam K. Wolfrum's How to be a “Swashbuckling Captain of Capitalism” by Patrick Byrne.

    Topics: 
    Politics
    Business

    Comments

    I've got to say, I've been a programmer at a couple of software companies and I've never had room to complain about my compensation. (Don't tell my boss that, though.)

    I think you make some very good points, but I'd say there are at least 3 value systems at play: merit value, market value, and value added. The difference between merit value and value added is that by "merit value" I'm referring to the "true" value of an employee to a company. In a perfectly efficient market system (or while riding invisible pink unicorns), you would expect market value to approach merit value. By "value added", however, I mean the value to society. By this measure, salespeople rank much lower. They're quite important to the company, but no ways near as important to society. (That's not to say they have zero value added, however. A good, ethical salesperson also acts as an educator.)


    by Nebton on Fri, 10/23/2009 - 1:12pm

    Yes, I thought about including value to society under merit value, but decided not to cloud the issue. "Value added" has a very different connotation in business vocabulary, so let's call it "social value." Like merit value, social value is amorphous and only loosely tied to market value. There is some connection in that what people want for themselves often correlates to what is beneficial to society, but there are many obvious exceptions, e.g. hummers. The government can of course play a role in rewarding social value by putting money into worthwhile projects (e.g. research grants) and taxing/regulating products with negative social value (e.g. pollutants), but these approaches are very targeted. In general, market values rules.

    But I disagree that with your contention that market value approaches merit value. That's a fallacy that I obliquely attacked in the article. Within a field, the best and brightest should rise to the top of the income pyramid (in an efficient market). But a perfectly efficient market would still reward bankers more than humanities professors, not because the bankers are more intelligent or capable on a broad scale, but because the bankers generate money for their employers. Indeed, I suspect that in a perfectly efficent market, bankers would make even more than they do now.


    by Michael Wolraich on Fri, 10/23/2009 - 1:33pm

    I think the disagreement differs more on our definitions of "merit value". I believe your definition is a mixture of my definition of "merit value" and the "social value". If the bankers generate more money for their employers than humanities professors, then they have more "merit value", by my definition. By contrast, "market value" also factors in such things as how many bankers vs. humanities professors there are, whether those who work in that field are willing to accept lower salaries (an issue in female-dominated vs. male-dominated fields or fields with more immigrants), etc.


    by Nebton on Fri, 10/23/2009 - 3:31pm

    No, I think that you misunderstand what I mean by merit value. Merit has to do with personal qualities, not social or economic contributions. We tend to think that someone who is smart, well-educated, hard-working, and experienced deserves to be paid more than someone who is stupid, uneducated, lazy, and inexperienced, regardless of the job, but the stupid, lazy person may actually have more market value depending on the respective careers of the two individuals.


    by Michael Wolraich on Fri, 10/23/2009 - 3:40pm

    You have clarified it some for me, but our difference of opinion still differs mainly in how we're defining "merit value". For my definition, "merit value" is tied to the employee's actual value to the company, divorced from how little the boss can get by with paying him/her, whereas "market value" includes that last little bit (which is one reason women get paid less than men).


    by Nebton on Fri, 10/23/2009 - 4:14pm

    Sure, I understand the semantic differences, but it's my post, dammit, and I defined merit value the way I did to make a point. Write your own post about your version of "merit value." :)


    by Michael Wolraich on Fri, 10/23/2009 - 4:24pm

    Very well written, G.  You generally make a good argument as far as merit versus market goes, but I think you give short shrift to the dominance of the short-run.  The problem isn't that i-bankers make more than janitors.  The problem is that they make many, many times more to take very risky short-term bets.  The janitor must show up to work each day and perform his duties to the satisfaction of his superiors lest he should find himself out of a job.  This isn't the case for i-bank CEOs and other top level i-bank executives.  If it were truly about the market, as you say, the top i-banks wouldn't even exist at this point and this conversation would largely unnecessary.

    Part of the problem is that they essentially have no superiors at this point.  In theory, they are supposed to be answerable to their shareholders, but shareholder governance does not seem to operate very well at this point.  Perhaps this is because shareholders, too, are only interested in short-term gains.

    Or perhaps it's because none of these parties have any down-side risk.  I-bankers get massive compensation and bonuses when they bet big and win big.  When they don't, they get bailed out by the taxpayer and still get their massive compensation and bonuses.  And the shareholders are in many cases made whole by the taxpayer as well!  Under these circumstances, why would they behave any differently?  This is askin to bankrolling a trip to Vegas for someone and telling them that no matter how much they win or lose, they'll get a nice, fact payday on their way home.  It's not difficult to guess how most people would behave under these circumstances.

    Another interesting point is that executive pay has not only continued to soar to higher and higher multiples of working wages, but it's also radically out-stripped what executives at the same level get paid in other countries.  The European counterparts of American i-bankers make much less (like less than half) of what American execs make.  Japanese execs make even less.  These people are no less smart and talented.

    More importantly, they're no less close to the money.  I think this is the weakest part of your argument.  I, too, have worked in the environments you describe, but they're aren't analagous to the circumstances present in i-banks.  In the environment you describe, I think your argument holds, but it's worth noting that these sales people frequently have a base pay that's barely enough to live on and receive the majority of their compensation in the form of commission.  The logic for this is obvious: Sell more, earn more.  That's what the company wants to incentivize.  It's not that the market has determined that sales people are worth more.  It's that by offering them this kind of compensation structure, the company incentivizes sales.  And it's important to point out that the incentive works both ways.  Sell more, earn more, but make less and you'll earn just enough to get by.

    As an example, my brother-in-law has worked in auto sales for years.  Fortunately for him, he now manages instead of selling.  Auto sales are cut-throat as hell, moreso now than ever.  The shadow of down-side risk looms large presently.  In the i-bank world, "close to the money" is just another way of saying close enough to put their hands on it.  The down-side risk is all on the taxpayer.  Using the term "market pay" to describe how these people are compensated is something of a joke.

    So, we shouldn't accept that it's just market pay and that the subsequent inequalities are just the nature of the beast.  Regulations, and thus incentives, are different elsewhere and that's just fine.  Not merely coincidentally, these other environments bear a much closer resemblance to a market.  This is also where we need to point out that the financial sector has become the biggest contributor to both Democrats and Republicans.  They paid big money to get the rules made and they're paying big money to keep it that way.  Obama just picked up another couple of mil from them at a $30k/plate dinner.  If all they needed to justify and earn their pay was the market, then what's all the grease for?

    We can and should emulate more stable systems.  The i-bank casino does nothing but extract value from the economy to line private pockets.  This isn't just populist pablum.  Our growth in intensive these days.  It comes from increases in productivity.  I-banks don't increase productivity.  The financial sector has, however, ended up with the lion's share of recent growth, despite wages that stagnated for everyone else through the Bush administration and despite the fact that it was the American worker that became more productive.

    I don't say this just to rage against the machine.  Such a system is not sustainable.  You simply can't expect to keep paying people less and less for being more productive, all the while taking their tax dollars in order to put them in private hands, and expect that they're going to swallow "market pay" as an explanation.  This is the stuff of guillotines production.

    Which brings me to taxes.  What you say about conservative anti-tax rhetoric is true.  The narrative you use actually ties in very nicely with Lakoff's explanation of the conservative moral system, which is the strong father model.  Under this model, those who earn heavily did it because they were brought up good and strong to succeed in a tough world.  The converse of this is that those who don't earn heavily failed to do so because they didn't deserve it.

    But this narrative doesn't work so well for the middle class.  Why?  They aren't rich.  If they consciously buy into this, it's because they don't deserve it.  I know that last year, thanks to Joe the Erstwhile Plumber, we discussed that some people seem to think that it could or will someday be them and that they thusly will have deserved it once they get there (they don't want their dreams taxed), but there's another piece of rhetoric that I hear quite frequently, which is more or less just anti-statism.

    It's the old "robbing Peter to pay Paul" argument about whether the state has the moral authority to tax and spend.  I think this one is far more prevalent among the rabble.  After all, the TEA in the modern tea party craze has been made into an acronym: Taxed Enough Already.  Nevermind that the middle class didn't pay appreciably lower taxes under Bush.  Nevermind that Obama hasn't raised their taxes.  Nevermind that they have representation.  Hell, nevermind that the American Revolution wasn't really about taxes anyhow.

    Regardless, the rhetoric I hear from them and from the likes of Jarvis and Norquist isn't the merit argument you describe, but rather the anti-state argument.


    by DF on Fri, 10/23/2009 - 2:30pm

    I can always tell a DF comment at first glance because it goes below the scroll. Thanks for the detailed response. I don't disagree with you about the dominance of the short-run, which you have laid out elegantly as usual. I only briefly alluded to it not because it's not important, but because I consider to to be a separate question. Unchecked markets are subject to disastrous extremes, and governments should regulate them in order to avoid unhealthy spirals. But from that point of view, the problem is not that bankers make more than they deserve; it's that their compensation structures are bad for the economy. This gets at the social value that Nebton raised, not the merit value that seems to generate the most anger from Wall Street haters. Consider the possibility that banks reduce bonuses in favor of straight salaries--which they have been doing to an extent. That would help with the market problem, but it would not appease critics who are concerned about the merit issue.

    Of course, the market problem will not be solved by token measures at bailed out banks either, but the 500K salary cap doesn't even address it. It's just red meat for the angry rabble. So let's at least honestly acknowledge that compensation is distinct from merit and focus our efforts on actions that keep the market moving smoothly.

    Regarding Europe, CEO income is certainly lower there, but I don't think that average banker compensation is that much lower, which is why American banks are worried about losing talent to Deutsche Bank and UBS. British and Icelandic banks didn't do particularly well in the collapse either. In any case, insofar as there are differences, it could be that the market has pushed U.S. salaries artificially high, in which case they will come back down, or it could be that cultural factors dampen the market pressure in Europe. If the latter, you could make a case for re-establishing cultural dampeners here, but I don't know how you would accomplish it.

    You are correct that conservatives also dislike taxes because they distrust big government, but the question of the government's tax authority falls back on the term you highlight, "robbing." Taxation only seems like robbery if you regard income that you have yet to receive as rightfully your own, and "wealth redistribution," as Limbaugh likes to call it, only seems evil if you believe that people naturally deserve everything that someone is willing to pay them.


    by Michael Wolraich on Fri, 10/23/2009 - 3:33pm

    Heh.  Well, apologies for being so verbose, but I've been thinking about and studying a lot of this stuff lately and your post got the wheels turning.  So, it's your fault!

    The UK and Iceland were outliers in the European zone.  Iceland's was the worst economic collapse in recent memory, but it's because they couldn't do what we can: Create more money to pay debts.  It's the same reason that states have had so much trouble under conditions where the federal government can just roll alaong.  The UK, especially the London financial center, is not appreciably different than the NYC financial center.  Let's not forget that AIGFP is in London, not NYC.  The fact remains that these outliers bore more resemblance to our system and they did worse.  Those that have saner systems fared much better.

    The salary caps alone don't solve the entire problem, but they aren't simply red meat for the rabble.  The American taxpayer owns 80% of AIG at this point.  30% of Citi, etc.  Changing the incentive structure away from the one that enabled this mess is nothing but sound corporate governance.  We want to incentivize decisions that will protect our long-term interest as shareholders.  That's what's supposed to happen.  No further argument for doing so is required.

    RE: taxes, I don't think that distrust of big government gets it.  The whole concept of "big government" is a ruse.  Those who decry "big government" don't mind it when they see it as a benefit, ex. defense.  Really, I think that anti-statist is the correct descriptor for the rhetoric that I was referring to.


    by DF on Fri, 10/23/2009 - 4:03pm

    I don't have a problem with the salary caps. I just don't think that they accomplish much, and I'm highly skeptical that the primary rationale was shareholder responsibility.

    Fair enough, anti-statist and big government aren't the same thing, and anti-statism does better describe current conservative doctrine, but I'm more concerned with the rhetoric than with the doctrine. What seems to get rank-and-file conservatives most incensed is the idea that the government is "stealing" what rightfully belongs to hard-working businesspeople.


    by Michael Wolraich on Fri, 10/23/2009 - 4:21pm

    I'm not sure of the reason for your skepticism.  If we accept that incentivizing poor, risky decisions is the core of the problem, then it seems to follow that we address said problem by changing the incentives.  In this light, changing the incentives doesn't have anything to do with making some judgment as to what is "deserved" by anyone, but rather about incentivizing better choices.  Understood this way, the merit v. market argument is broken on both sides because it's not about merit and, as I've described, compensation is not, in fact, subject to the market, primarily thanks to the TBTF doctrine.  The problem is that they are insulated from failure.  The individuals making these decisions cannot be so insulated if we're to have an honest expectation of sound decision-making.  Buying 80% of AIG and allowing them to maintain the same incentive structure is tantamount to insanity.

    I'm likewise not sure why you think that's what moves the rank and file.  When I talk to people that hold these views, they don't seem to be overly concerned with business people somewhere doing well.  They're concerned with themselves.  They've been told that taxes are crushing them, despite the fact that tax levels haven't appreciably changed while wages are failing to keep pace with inflation.  Even so, they know that they're working harder and getting less for it.  They've just been lied to about why.

    To be clear, I'm not claiming that I know better than you, but that just hasn't been what I've encountered.  I'd very interested to hear more about why you see it that way.


    by DF on Fri, 10/23/2009 - 4:32pm

    I'm skeptical because I assume that much of what the government does is for political reasons, and there's heavy political pressure from the left to punish the greedy bankers. That doesn't mean that politics is the only rationale, and I've course, I'm not privy to an White House meetings.

    With regard to statism, I'm going off the rhetoric from pundits. Limbaugh and others now call taxes "wealth redistribution." Wealth redistribution would offer economic benefits to the non-rich, but non-rich conservatives still fiercely oppose it, just as they fiercely oppose rolling back Bush's tax cuts for the rich. I also recently read a "Robin Hood" reference from some conservative, as in "Robin Hood was a thief", but I can't remember where. Again, Robin Hood steals from the rich, gives to the poor. Statism is also a common theme, but I've seen it more in highbrow doctrinal explanations. That said, I haven't studied the conservatives' recent economic position that much, and I'm sure that my perspective on this just reflects what I've happened to read.


    by Michael Wolraich on Fri, 10/23/2009 - 5:20pm

    Does it really matter whether their primary motivation is political?  There's an incredibly sound argument for doing it.  It's simply the responsible thing to do.  How often do politicians do things that are responsible, but not politically motivated?  I'm not going to hold my breath on that count, so I'll accept the coincidences as happy events when they occur.


    by DF on Sat, 10/24/2009 - 12:55pm