UPDATE: AIG CEO Benmosche Says He Isn't Leaving

Is there a rebellion brewing over at AIG? Apparently, not. The Wall Street Journal reported today in an exclusive piece that AIG CEO Robert Benmosche had informed the board that he's "done" after only three months on the job. He was reportedly fed up with government regulation, especially when it comes to compensation at bailed-out companies like AIG. According to Reuters, Benmosche denied that the report was true. He said on Wednesday that he was "totally committed" to staying at the company, countering an earlier report that he was considering stepping down, Reuters said.

Reuters also said it had obtained a copy of a letter to employees, in which Benmosche said he and the company's board are "frustrated" about restrictions on pay and are in discussions with the U.S. government about them.

The drama at AIG raises some interesting questions.

Just a few weeks ago, Obama administration executive-compensation "czar" Ken Feinberg ordered bailed-out companies such as AIG to cut total compensation for top executives by 50 percent. Benmosche had previously landed a contract worth about $10 million, although it was loaded with clawback provisions that allow the company to revoke pay under certain conditions.

One can argue from now until the end of time about the merits of government-imposed pay restrictions on bailed-out companies. That debate is really beside the point, though. The key question is whether these restrictions will achieve their purported goal of limiting egregious risk taking. The idea behind these restrictions is that companies got out of hand because executives personally benefited from taking risks that allowed them to show a huge profit, even if those profits evaporated over time. There was also an ethical case to be made. Why should leaders of bailed-out companies profit as before, even though their companies required huge taxpayer-backed bailouts in order to survive?

It's unlikely that pay restrictions will do much good when it comes to making the system safer. They made handicap certain bailed-out institutions such as AIG, making it harder for them to retain their most sought-after employees. But as long as executives are free to go to other companies in the U.S. or elsewhere and operate without limits on pay, outsized compensation packages and the practices that support them will be a function of the market.

There's really no middle ground when it comes to policing executive pay. The only truly effective way to control pay is to control pay for everyone, everywhere. Otherwise, the best of the unregulated employees will pay as they chose, and the weaker, regulated institutions will have to compete as best they can with whomever they can attract with the pay the government will accept. This system will fulfill the goal of punishing bailed-out companies. But it will do nothing to change the system in the absence of effective global controls on compensation, and that is never, ever going to happen. The most realistic scenario is that bad actors will be punished, and that the weak will get weaker and the strong will get stronger.