Anthony de Jasay

The Capitalism They Hate. Part II. Indecent Earnings

Anthony de Jasay*
At the end of 2006, a year of which the financial services industry had little reason to complain, the head of Wall Street's most prominent investment bank was rewarded with a bonus of $40 million. Some less prominent houses gave their heads bonuses ranging from $20 to $50 million. Very successful security or commodity traders were given twice or thrice the bonus of their own chief executives.

Promoter-managers of what are, in most cases quite misleadingly, called "hedge funds" (for few of them really hedge anything) who take 1 per cent off the bottom year in, year out and 20 per cent of gains off the top had no reason to complain either. Their investors ran greater than average risks but most of them were fairly well rewarded by the 80 per cent of the gains going to them. The managers took no risk and their 20 per cent share made some of them a very large fortune in a single year.

Some top corporate executives, in fact employees of the shareholders, received compensations in the low to middle eight figures for loss of office, in addition to their pensions, when asked to make room for someone else. Golden handshakes were of 24 carats, often awarded by board committees whose members were acting by the Kantian rule: Do as you would be done by.

Promoters of private equity funds, unlike directors of publicly held corporations, have great freedom to operate with borrowed capital and are indeed encouraged by their investors to run high risks by using high leverage. By good judgment and good luck, they usually succeed in making astronomical fortunes for themselves while their investors are adequately but not indecently rewarded for carrying most of the risk.

Part of the public in the United States, and a tiny handful in Europe, contemplates these spectacular earnings with admiring awe. Everyone else considers them indecent. They provoke the most virulent kind of hatred for capitalism.

The reason is not so much the vastness of the sums involved and the glaring inequalities they create, as the great ease with which they seem to come by and the perversity of the value system they are supposed to reflect (though there is no reason to suppose that they reflect anything like a value system). Glaring inequalities are as old as history, and though they were occasionally rebelled against, they were not really perceived as indecent, esthetically disgusting and morally reprehensible. All ancient empires were extremely inegalitarian. The states of ancient Greece appear to have been fairly egalitarian with the king perhaps ten times richer than the shepherd or the fisherman, but in ancient Rome the wealth and income of a rich senator must have been thousands of times greater than that of the proletarian plebs, let alone his outdoor slaves. Many of these differences were a matter of hierarchical status and were part of the tacitly accepted established order of things. There is no compelling reason why some of capitalism's inherent inequalities should not in the fullness of time also be so accepted or (more probably) grudgingly acquiesced in, though the reasoning spirit of enlightenment will want to understand why the established capitalist order deserves at least tacit acceptance.

The same forbearance would be much harder to obtain for the inequalities due to "indecent" earnings. One obstacle in the way of their social acceptance is that they accrue to upstarts, fast-talking, fast-moving smoothies who have had too easy a ride to the top. They are too unlike the Dick Whittingtons and the legendary shoeshine boys who overcame adversity and rose by hard work and harder thrift.

But a possibly deeper reason is that there is little or nothing in the "indecent" multimillionaires that strikes the observer as truly entrepreneurial. They do not invent and do not make things that the market might either accept with pleasure or reject with indifference. They take few or no risks, but are parasitic on the risks taken by their investors and clients. Many of them are pure intermediaries, a function whose contribution to the economy is seldom appreciated by the wider public. Others, typically executive board members of large corporations, appear to be abusing the principal-agent relation and though they do serve their principals, the shareholders, with moderate zeal, they serve first and above all themselves. Paying them with stock options is designed to attenuate the principal-agent problem (and it does resolve it to some extent), but is on the contrary suspected of being a corrupt practice fixed up by crony directors who expect to be similarly fixed up in return.

Most of us react to the decency or otherwise of large incomes and quickly made fortunes by moral reflexes that evolved under the capitalism of a generation or two ago. They have not yet been adjusted to the changes capitalism has since undergone. One such change is the flood tide of pension funds in the Anglo-American type of capitalism which, after all, sets the mode of operation the rest of the world is beginning to imitate. The needs of pension funds and the competition between their managers sets the maximisation of asset values as the primary goal, and the more classic goal of profit maximisation by corporate enterprise tends to become a mere instrument of the primary goal. Socialists whose rejection of the "system" is visceral rather than intellectual, call this "Casino capitalism," run by and for "speculators".

An even more far-reaching change is the great increase of financial relative to non-financial capital in private ownership. This is no doubt due to ever greater intermediation, which in turn is a by-product of the splitting up of risks and the distribution of different types of risk-bearing instruments among those most willing to carry each particular type. One result is the availability of immense pools of financial capital demanding what by historical standards looks little in the way of risk premium.

How all this leads to "indecent earnings" is clear enough. Corporate assets are now very mobile. They are readily hived off or re-assembled. Whole corporations merged with others at the drop of a hat with or without the intervention of private equity firms, often spurred on by advisers eager for commissions. On the whole, this is probably a good thing, as it makes it much easier to re-deploy assets from less to more productive uses than was the case only a couple of decades ago. Today, a 2-3 billion dollar merger or acquisition hardly makes the financial columns of the press, and a deal must exceed $20 billion to make real news. Consider a $20 billion deal. The principals on either side are probably prepared to pay some fraction of the deal's value to make doubly and trebly sure that there is no hitch, that nothing has been overlooked, that regulatory problems have been duly considered and there is no flaw in the documentation. One per cent of this deal would be $200 million. In fact, the teams of bankers and the batteries of lawyers will between them probably share a 0.5 per cent fee—an absurdly high sum that is absurdly low relative to what an avoidable mistake or a derailed transaction would cost. Competition should keep the fees down, but the need for the advisers to have prestigious names will keep them up.


To read about the Sarbanes-Oxley Act of 2002, see Sarbanes-Oxley (SOX), Belts and Suspenders: The Regulatory Aftermath of the Corporate Accounting Scandals, by Richard Mahoney.

The outrage roused in the public by such sums being thrown around may stir politicians to action against "indecent" earnings. Capitalism would presumably be less hated, and more assured of survival under majoritarian voting, if such earnings could be outlawed or otherwise wished away. On mature reflection, however, any legislative or regulatory remedy is likely to prove worse than the disease, ultimately leading to evasion, corruption, immobility and an ever-lengthening series of further measures to correct the perverse effects of their predecessors. The experience made with the Sarbanes-Oxley legislation in a somewhat different domain should serve as a lesson before it is decided to let politics deal with indecent earnings.

The least bad remedy is still to leave it well alone. It is a remedy that, for all its homeopathic modesty, has a shining virtue. Experience shows that people who have made indecently large incomes sooner or later seek to earn the esteem of their fellow men by making correspondingly vast donations to good causes. If anyone is ill-tempered and ill-informed enough to think that Warren Buffett's gains are indecent, he should be told that the gentleman in question has recently donated $35 billion to charity. All big earners are not like him, but even the most unpleasant characters tend to end up doing the right thing in their testaments, if not sooner. Society has ways of exerting gentle but persistent pressure on the new rich to do good after they have done well and yet leaves them with the satisfaction and good conscience that voluntary benefaction affords them. It is surely best to leave things at that and not wreck the chances of the world's poor by trying to make the very rich less rich.

*Anthony de Jasay is an Anglo-Hungarian economist living in France. He is the author, a.o., of The State (Oxford, 1985), Social Contract, Free Ride (Oxford 1989) and Against Politics (London,1997). His latest book, Justice and Its Surroundings, was published by Liberty Fund in the summer of 2002.

The State is also available online on this website.

For more articles by Anthony de Jasay, see the Archive.
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