TODAY'S COLUMNIST

Column : Don’t compare nickel to aluminium

Ajay Shah
Posted: Thursday, Jun 25, 2009 at 0212 hrs IST
Updated: Thursday, Jun 25, 2009 at 0212 hrs IST

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: Financial regulators must take interest in how the incentives of bank managers are shaped by ownership, governance and compensation. But a mere focus on the level of compensation is giving in to the populist envy of the rich. RBI needs to come out with a policy document on ownership, governance and compensation, based on high quality economics and public discussion.

Nickel costs $15,400 per tonne while aluminium is at $1600 a tonne. Why should nickel cost ten times more than aluminium, even though they are a lot alike? Such questions are pretty pointless. Prices come out of supply and demand and have no other interpretation. AM Naik of L&T got paid Rs 8.4 crore in 2007-08 while Azim Premji of Wipro got Rs 1.31 crore. But interpersonal wage comparisons are as pointless as intermetal price comparisons.

When India became a socialist country, the government took upon itself to control all kinds of prices, ranging from metals to labour. Unethical firms found other ways of paying employees, which tilted the balance in favour of bad ethics. Lowered wages at the top reduced the incentives for young people to work hard and learn hard. Low wages pushed the brightest people out of the country. Inward migration of talent did not happen.

One of the most important reforms of the early 1990s was the removal of government involvement in wage setting. This fit into the larger theme of reforms refocusing government on the provision of public goods, and the removal of government interference in prices of the factors of production: land, labour, capital and enterprise. Deregulation of wages induced a sea change in the quality of the Indian workforce, based on stronger incentives in favour of hard work and education, a reduction in emigration, a reverse brain drain, and foreigners moving to India.In this setting, debates about compensation in banking have resurfaced. With ordinary corporations, good corporate governance is about getting managers to maximise for the shareholders. This involves compensation packages containing shareholding, performance- linked bonuses and stock options.

In finance, in many situations, managers who think like shareholders can be pretty destructive. In banking, we have seen huge bonuses tied to short-term performance, without concern for risk. Excessive risk taking was consistent with bonus-maximisation. While such problems occur in other parts of finance also, they are particularly important in banking, given the toxic combination of opaque assets, high leverage and government guarantees. Many decisions taken by...

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