Last summer, Richard A. Posner, a federal appeals court judge, issued a surprising and prescient dissent. Executive pay is out of control, he said, and the marketplace cannot be trusted to rein it in.

Judge
Posner is a conservative with libertarian leanings, and he is a leader
of the law and economics movement associated with the University of Chicago.
He often relies on economic analysis in his judicial decisions, and he
believes that many questions are best sorted out by the marketplace.

But
corporate America has insulated pay decisions from market discipline,
Judge Posner wrote. “Executive compensation in large publicly traded
firms often is excessive,” he added, “because of the feeble incentives
of boards of directors to police compensation.”

The Supreme Court
will hear the case this fall, as anger over huge bonuses paid to the
executives of failing companies continues to grow. The case, Jones v.
Harris Associates, may turn out to be the court’s first significant
statement on the corporate culture that helped lead to the Great
Recession.

The case arose from the enormous fees mutual funds
pay to their investment advisers. A three-judge panel of Judge Posner’s
court, the United States Court of Appeals for the Seventh Circuit, in
Chicago, threw out a lawsuit brought by the investors in three Oakmark
mutual funds who said the funds had overpaid their investment adviser,
Harris Associates.

The panel decision,
written by Chief Judge Frank H. Easterbrook, another leader of the law
and economics movement, said the marketplace could be trusted to
regulate fees. Judge Posner, dissenting from the full court’s decision
not to rehear the case, said competition had not been effective in
keeping the compensation under control.

Before last year’s
market collapse, the mutual fund industry held more than $11 trillion
in retirement and personal savings, and it paid advisers perhaps $100
billion in fees.

Mutual funds
are odd enterprises. They are typically formed and run by their
investment advisers, which select the fund’s board of directors. That
board then negotiates the adviser’s fees.

Here is how Warren Buffett analyzed the situation in his 2003 letter to shareholders: “Year after year, at literally thousands of funds, directors had routinely rehired the incumbent

more...http://www.nytimes.com/2009/08/18/us/18bar.html