Cap Leverage, Compensation Will Follow

The recent letter from David Einhorn contains many wonderful nuggets. One I’d like to highlight is a simple and elegant solution to the problem of excess compensation on Wall Street. He states:

I believe most of the discussion about compensation at financial institutions is a populist diversion. If the goal is to avoid excessive risk in the system, the proper response is to reduce it directly by enforcing much greater capital requirements. The lower leverage will also have the side effect of reducing the future peak returns, which will mean less egregious compensation.

Sometimes the best solution is the simplest. Instead of creating an expensive bureaucratic monster led by a Special Master of Compensation (give me a break), the simplest and most direct way to limit executive compensation is to reinforce existing SEC regulations that limit leverage.