The foundation of a free market economy is the sanctity of contracts. Think about it: what would happen if a farmer refused to deliver his crop at the price he agreed to in a futures contract? Or if borrowers could opt out of paying off their debt without consequence? What if the government introduced political considerations into the contractual relationship—where one party could be given a pass by Congress, leaving the other party high and dry?
Chaos would result. When a party fails to uphold his end of the deal, he faces a lawsuit, loss of reputation, or prosecution in the case of fraud. But if the failure is government sanctioned, there is no recourse for the wronged party—he must absorb the loss and consider future contracts in the light of possible default. If he is smart, he’ll restructure the next contract so that it is beyond the government’s reach; if things are really bad and the rule of law is in question, he will forego whatever economic activity is being targeted.
Employment contracts are just like any other contract in this regard. A company hires an executive and promises to pay a salary plus bonuses, benefits, and stock options. In return, the executive promises to do whatever job he was hired for. The executive seeks the most income he can make while the company offers the least compensation it can. In the end after a process of negotiation, the two reach a mutual conclusion and a contract is inked.
The government’s role in this negotiation is to provide recourse should either party fail to live up to its obligations in the contract. It does not get to decide whether the deal is equitable. It does not get to say that the medical plan is too generous, or that there isn’t enough stock options. The only way it can inject itself into the process is with a gun.
That is, sadly, the history of employment law in America. If an employee is willing to work for $2.50 per hour and an employer can only pay that amount, the government has said that it will prosecute the employer if that contract is drawn. If an employer says that it will only hire a person if she promises not to join a union, the government will nullify that contract and fine the employer if it is discovered. And now, if a company pays its CEO millions of dollars to turn a company around, the government can deny that CEO his earned pay if it deems the CEO’s performance unsatisfactory. We now have the repellent sight of heads of companies dragged before Congress to defend their legal contracts.
People may think they know better than a corporation’s officers how much a CEO deserves, but that is wholly irrelevant. If the Board of Directors pays dearly or offers compensation untied to performance, then that is between it and the shareholders. If they don’t like executive compensation policies, they can sell their shares or replace the board. Petitioning Congress to second-guess employment contracts is fraught with peril.
The government should be in the business of enforcing contracts, not subverting them. Whether or not executives are worth their pay is not a social issue; making it one puts all contracts in peril.