Confident Uncertainty, Excessive Compensation, & the Obama Plan

Public outrage at the enormous bonuses TARP recipients paid to senior executives recently prompted the Obama Administration to impose sweeping new curbs on executive compensation. Shortly thereafter, Senator Dodd added restrictions on executive bonuses to the stimulus bill President Obama subsequently signed. These are understandable political reactions, but will they achieve the twin goals of reducing executive compensation in recipients of federal assistance while spurring better corporate performance? To examine this question, I analyze excessive compensation as the product of "confident uncertainty," the tendency of even the most sophisticated actors to place unwarranted confidence in their ability to predict the future. In particular, research from psychology and behavioral law and economics argues that employers demonstrate misplaced faith in their ability to distinguish among closely comparable candidates and therefore vastly overpay for talent which is not predictably superior. I apply confident uncertainty to explain why corporations may pay their senior executives too much. These insights on the root causes of excessive compensation grant valuable insight into the likely impact of both the Obama Plan and the Dodd provisions. I argue the Obama Plan's cap on pay is likely to prove effective in countering cognitive uncertainty, but it should be tailored to a corporation's particular circumstance and apply to performance pay as well. I also contend the non-binding "say on pay" provisions in both the Obama Plan and Dodd provisions are unlikely to curb excessive pay. Finally, I conclude that the Dodd provisions' cap on performance pay are a step in the right direction, but contain loopholes likely to seriously dilute any predicted benefit.