Econ: Economics and Principal-agent Problem Essay

Submitted By adria20
Words: 942
Pages: 4

1. What’s the economic issue you have chosen to write about, and why is it important?
The economic issue that I have chosen to write about is the issue number 2, which is “Should the compensation of executives be subject to government regulation?”. The question of whether CEOs of major companies are overpaid has been a constant subject of interest for many years with so many different answers and opinions about it. But, nowadays, this question has taken a bigger dimension. The reason why more people are concerned right now than in the past about the compensation of executives and the reason why the government has started to impose new regulations is due to the global financial crisis that started in 2007-2008, which caused a huge economic slowdown in the economy. Moreover, another cause is the steady increase of the compensation of executives of financial institutions, as a study of Edwards School of Business claims, even though their companies were “supposedly” in trouble due to the slowdown.
The recent financial crisis generated so many problems in most of the economies around the world and as a result those economies entered into a recession and a large percentage of people who were employed lost their jobs. For example, accordingly to the US Bureau of Labor Statistics, US seems that is recovering from the crisis and the unemployment rate is decreasing a little bit, but in 2010 the unemployment rate was around 10%. Other countries in Europe, such as Spain, are much worse than US. Spanish unemployment rate right now is 27%, as the INE (Spanish National Institute of Statistics) indicates.
So, how can executives of financial institutions have higher compensations than before during the slowdown? It does not make sense that a lot of people do not even have money for food because they lost everything during the crisis and the “alleged” creators of the financial crisis are earning more now. This is why compensation of executives has been a subject of intense debate among regulators, the media and people during the last years.
2. What are the two sides on this issue, and which side do you tend to agree with?
In this issue we have two completely different opinions. On one hand, Stiglitz argues that compensation of executives should be subject to government regulation because he thinks that “regulation can help to better align the private rewards and social returns” (Taking sides 21). He focuses his argument on the recent financial crisis and how a deregulated market led the financial market to an excessive risk taking and to the failure of its roles: managing risk and allocating capital, what caused the financial crisis. He also argues that compensations were high before the crisis, when CEOs’ performance was “supposedly” good, but compensations were also high and even higher after the crisis, when all financial companies were in trouble because their CEOs did not do a good job. On the other hand, Kevin J. Murphy has a totally different opinion. He does not believe that compensations should be regulated and makes several arguments to defend his opinion such as that there is not enough empirical evidence to state that the actual compensation system leads to excessive risk taking.
In my opinion, Stiglitz’s view that compensations should be regulated is the better one and the one that I agree with because I think that the free compensation system leads to principal-agent problem and moral hazard. However, I also think that the regulation should be only made in the financial market because it is a private market but through the government safety net they use public money when they are in trouble.
3. What’s the economic argument that supports your side?
During the financial crisis the US…