Why Executive Pay is an Example of Market Failure

If the market worked properly, the owners of the firms would pursue their own economic interests and only pay out enough to attract and retain sufficient staff. The actions of staff to maximise their own compensation, using pay levels at other firms as justification, would be constrained. Many banks are still making a return on equity below their cost of capital so maybe, finally, pressure from shareholders may come. The high levels of pay in the Investment Banking industry have not only been used to set high levels of pay in Asset Management companies, but have rippled through not only other industries, but the public sector as well. Every time there is outcry over the high level of pay for some public employee, the answer is always the same…”We need to pay to attract high quality staff”. So senior executive pay across the board is constantly being pulled up to match the highest observed level and so on, and so forth…..