Let the market sort it out

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Let the market sort it out

The Financial Supervisory Service plans to embark on an overall review of the wages in financial holding companies and banks. The investigation could expand to insurance and brokerage companies to cover the entire financial industry. It wants to find out if executives and employees in the industry deserve the relatively generous pay and bonuses. It aims to come up with guidelines on pay packages after the investigation. But the regulator is actually targeting the top names on the executive roster to delve into their earnings gold mine.

Common salary-earners are dumbfounded by the figure - nearly 3 billion won - a chairman of a certain financial holding company earns a year. Moreover the executive payout rose steeply while the company’s earnings fell.

The controversy and public rage could lead to a tapering-off in executive pay in financial companies. But executive compensation should be determined by the economic value of executive contribution and the market demand. If the role and ability of a chief executive becomes crucial in shaping corporate performance, demand for capable executives and their market value would rise. Other factors can have an impact, but market appreciation for executive talent mostly determines compensation packages.

If the role of a chief executive is not that important in the financial industry, there is no need to grant a huge financial award for his or her service regardless of their capacity and experience. If executive pay in the financial industry rose sharply, it could explain that there are that many capable chief executives and that the market approves of their value.

Of course some would argue against this. They could claim that executive pay escalated because they advocate themselves as “agents” of the company’s shareholders and link pay plans to the firms’ stock price under the pretext that they are acting in the best interests of shareholders although they are actually out to increase their own wealth.

If so, excessive executive compensations could hurt shareholders. The FSS wants to fix what it deems as a flawed compensation arrangement partly because of the agency problem. But even if problems in the incentive pay scheme in financial institutions are caused by conflict of interest between management and shareholders, it does not justify the FSS or any other outside interference to solve them. A third party cannot have more information in the company and regulators cannot force managers to maximize shareholders’ interests.

Executive compensation in advanced markets goes up due to growing corporate size and role of top managers. New York University economists Xavier Gabaix and Augustin Landier in their study of executive compensation concluded that the spike in executive rewards correlate with the surge in market capitalization of American companies - that as companies get bigger, a talented CEO can have a greater impact. The correlation did not change even after the financial meltdown.

The role and capacity of chief and senior executives in local financial institutions have gotten bigger and vital following the establishments of large-scale financial holding groups through mergers and acquisitions in the wake of the financial crisis.

The escalation in executive pay also reflects the trend. The interference by the government and public institution in the corporate executive system could undermine corporate values and negatively impact the financial industry. Bureaucracy and government involvement could be the reason behind moral hazard in top management in financial institutions. That should be fixed first, before the compensation scheme is enacted.

*The author is the head of public policy research division of the Korea Economic Research Institute.

By Song Won-geun
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