Award winning economist Roger Bootle explains why we should seriously worry about how much senior corporate executives earn.
I suppose we all have an idea of people or professions that earn – or at least receive – more money than they deserve. My own favourite candidates include lawyers, estate agents and headhunters. Other people may well want to include economists although, for obvious reasons, I am unable to add the followers of that humble calling to my list.
One group that has come in for special attention over recent years is senior corporate executives – and particularly chief executives. The average CEO of a FTSE 100 company now earns – sorry, “takes home” – between £4 and £5 million a year. You might think that that is a sum well worth getting out of bed for. However, this pales into insignificance compared to senior executive rewards in the United States.
Why does this matter? To be fair, lots of people think it doesn’t, including parts of the Conservative-leaning press, which often argues that such rewards pose no significant issues for the rest of us. Sometimes they claim that such executives are paid so lavishly simply because their contributions to the companies that employ them is so enormous. In that case, why shouldn’t their companies’ pay them so well and why should we, who are the beneficiaries of successful companies’ activities, be at all perturbed?
In any case, it is up to their owners, and not the rest of us, to assess the value of senior executives and to pay them accordingly. In other words, it is simply none of our business.
I think that this view is fundamentally misguided. In the market economy all sorts of things happen which would not strike a fair-minded person as desirable or justifiable. But outcomes that are outrageously out of kilter with underlying reality or rough conceptions of fairness are not the norm. And when they occur, the market mechanism tends to cut them short.
The size and ubiquity of unjustifiable market outcomes has a key bearing on whether and how much popular opinion supports the capitalist system. In my view, during and after the financial crisis we came perilously close to a point where public tolerance was about to snap. This really matters. If support for capitalism falters, we will end up with socialism. That would mean lower pay for chief executives, all right. But it would also mean lower pay for everybody else too.
In practice, it is extremely difficult to measure the contribution of a chief executive. It is common to look at the progress of the company during the executive’s tenure as some sort of guide to what he or she has achieved. What has
happened to sales, profits or the share price are commonly used yardsticks. But as we all know from other walks of life, just because someone is there when the good news appears does not necessarily mean that they themselves are responsible for it.
Nor is pay determined in anything that could remotely be called a market. Big companies decide on senior executive pay as the result of the deliberations of a remuneration committee that consists of other executives from inside the firm and outside, nearly all of whom will come from the same coterie and will often sit on the boards of other such companies. My old friends, Sir Timothy Whatnot and Dame Eleanor Flibbertygibbet, are unlikely to rock the boat.
They are often aided in their deliberations by the services of firms of Remuneration Consultants who supply data about pay practices in other comparable businesses, broken down into four quartiles. It is common for such consultants to ask the board whether they would want their CEO to be paid anything other than in the top quartile. They usually don’t. You don’t need to be Warren Buffet to work out that if all companies are trying to get their CEO to be paid in the top quartile then, although they won’t all succeed, executive pay will continue to soar.
It is often alleged that it is necessary to pay chief executives these mouth-watering sums because if they are not so paid then said executives will leave and the company will thereby lose their services. This is a very weak argument. If a CEO is being paid far more than their real contribution to the business then it should be quite ok if the business loses them. There is a huge supply of executives ready and willing to step into their shoes.
The enormous sums paid to CEOs are the sort of rewards that in the past would normally have accrued only to entrepreneurs who might have risked everything to build their businesses. Now they are falling into the laps of mere corporate functionaries who have managed to climb the corporate ladder. Once there, they have all the corporate apparatus around them to enable them to ooze competence and a sense of gravitas. In practice, however, often they have risen without trace.
Fairness – and the perception of it – are one thing. But as an economist I am especially interested in efficiency and production. My fellow economist, Andrew Smithers, reckons that the move towards share price-based systems of executive remuneration in the United States and the UK over the last 30 years is primarily responsible for those countries’ sluggish economic performance. If you gear chief executives’ remuneration to the share price, this will incentivise short-term behaviour that tends to boost that price; equally, it will disincentivise long-term investment whose benefits will only show up some way into the future, long after said executive has moved into his perhaps not so well-earned retirement.
The aggregate numbers tell you that in both the US and the UK, fixed investment as a share of GDP has been pitifully low. Low investment means low rates of productivity growth. With low productivity growth it is bound to follow that average real incomes will grow only slowly.
These problems are comparatively recent in the evolution of capitalism. They didn’t occur in the classic early stage of the Industrial Revolution. For those top-hatted Victorian entrepreneurs who so often feature in the socialist rogues gallery but who, I think, ought to be objects of admiration, there was no conflict between ownership and management. They filled both roles. If they paid themselves “too much”, this money would come from themselves. By contrast, today’s executives are in conflict with the long-term interests of shareholders and the economy as a whole.
Things are not bound to stay this way. Institutional investors are coming to recognise their responsibilities in relation to executive pay. Over the next few years I expect to see their influence brought to bear such that, at the very least, senior executive pay stops rising at these ridiculously inflated rates. But it may take more than this actually to bring such pay down. This could well require changes in capital gains tax to tax assets held for short periods more heavily, and also changes to the rights of shareholders to receive dividends and to vote.
If you are familiar with my writings, I doubt that you will have thought of me as a socialist firebrand. You’d be right. If it comes to the revolution you won’t find me at the barricades. In fact, you are likely to find me ensconced in Boisdale enjoying my favourite tipple. My intense concern about senior executive pay is not because I disapprove of, let alone hate, the market economy, but actually the reverse. I don’t see these ludicrously high rewards as being the outcome of a market process in any realistic way. Rather, they emerge from the dealings of a club of like-minded and like-interested people.
I wish there was someone on these remuneration committees who was prepared to say that they thought it was appropriate that their CEO should be in the fourth quartile and that they wouldn’t mind if the current incumbent decided to seek their fortune elsewhere because there were plenty of other candidates available who would do at least as good a job for a fraction of the money.
I would willingly volunteer my services for this role. But, as you may have guessed, with views like mine, I haven’t exactly been inundated with offers of board directorships at major companies. I suspect that as I move into my anecdotage, I am just going to have to spend more time having fun, with or without the barricades.