Two thirds of Executives globally believe that they are paid too much and a staggering 77% of Execs in the UK believe the same. At least that’s if you believe recent research by Grant Thornton as read by The Independent. And why wouldn’t you believe it!
Shareholder Nice Weather (not Spring)
Although it’s not entirely fair to talk of a ‘shareholder spring‘ (as if trying to connect to the radical political upheaval of the Arab spring, or even of the breaking of a long winter), it is fair to say that the first stirrings of a wider-scale revolt seem to have occurred at this year’s round of AGMs in the UK. Shareholders are taking exception to the amount Executives are being paid, and taking the trouble to put it on the corporate register in record numbers.
What’s more, they are venting their frustration with some success – ask the CEOs of Aviva and Trinity Mirror who have resigned in response to shareholders voting down their remuneration package. Other CEOs escaped less worse-for-wear, but must have been feeling like they had their noses bloodied at their respective AGMs. All that’s to say nothing of the spectacle made of Stephen Hester’s RBS bonus and the political furore it created earlier this year in the UK, nor of the now mute shareholder dissatisfaction over Bob Diamond’s remuneration (mostly muted by his subsequent resignation after the LIBOR scandal). But why is this getting everyone concerned quite so hot under the collar? Surely we pay Executives only the amount the market decides that they deserve?
Almost whatever statistics you can find support the view that Executives are paid an alarming amount of money on a historical scale (or indeed any scale). The Final Report of the High Pay Commission in the UK highlights that wealth is migrating toward the already wealthy, so much so that it is trending toward the sort of wealth distribution last seen in Queen Victoria’s England (see below). The Commission concluded that it’s due in no small part to the wealthy wage earners in Exec and Senior Management positions. Traditional wealth has been transmitted through family lines or earned by entrepreneurs, but now it is possible to be wealthy while taking on the relative protection of being an employee (in the form of senior management employees). More so at the Exec level in the last three decades than ever before, with a forty fold increase in pay for Execs compared to a three-fold increase for average wage workers.
But wait – these Executives had met the contractual conditions of payment including, in some cases, the conditions required to receive a bonus. If you and I had shown up to work, met all the criteria in our contract, met relevant objectives, then we would be a bit annoyed and probably quite shouty if we weren’t then paid in full. So why shouldn’t Execs act the same way?
But equally if we destroyed any part of the value of the company that we worked for (by, for example, stealing or smashing its goods) we would expect to be summarily fired without any pay, let alone a parting bonus, but CEOs who underperform routinely achieve this feat. It seems that some corporations and virtually all CEOs are Too Big to Fail. I can’t imagine a company agreeing to pay the legal fees of an employee dismissed for destruction of property, and yet the Executives of Fannie May and Freddie Mac have had those companies pay their legal fees in defending actions against them personally for the failures related to the Global Financial Crisis.
How did we get here?
I barely know where to begin with this. It’s a really tricky issue, partly because for many it taps into some very deeply held beliefs about the supremacy of capitalism, partly because it is connected to the equally deeply held beliefs about dignity of those who are less well-off and partly because I work for an organisation that works a lot with senior business Executives.
In some senses, and because of the outrageous tension between the two sides, this feels like a boxing match (cue deep-voiced, syllable-extending announcer dressed very smartly in an Executive-worthy suit, with one of those cool silver ’60s microphones hanging from the ceiling on a black, electromagnetically-shielded, appear-out-of-the-sky cables).
Perhaps it should be the Red White and Blue corner (God save our gracious star spangled banner, and all that), but in any case, this corner is occupied by the neo-liberal, economically-charged capitalists. Prime among which is probably the Milton Friedman. Him and their repertoire of justifications about Executive remuneration includes classics like:
- We are in a competitive environment. As such, business needs to pay its Executives highly to stop them going elsewhere. The pro-nationalist variation of this includes Execs migrating to whatever overseas country will pay them more (the USA is often cited in this version, although any rich cousin will suffice).
- The market should decide the fees of top Executives. Supply and demand will lead to correction of the price paid for Executives.
- Top pay is linked to top performance; it’s only the best of the Executives who get paid the really high amounts, as a direct result of their out-performance of others. This is the ‘Superstar’ argument.
- High Pay motivates people.
IN THE RED CORNER
And I do mean the RED corner (although only tongue in cheek – there aren’t any real communists anymore), is occupied by those who seek to put limits on pure market mechanisms, and possibly some deeply pragmatic capitalists (I think they exist!). Prime among them is probably R. Edward Freeman. Their arsenal includes arguments like:
- Stakeholders have a legitimate interest in the outcomes, and therefore, the governance of companies. Employees and societies, as major stakeholders in any firm, have an interest ensuring that the behaviour of Execs aligns with stronger and more effective societies.
- For the longest time, societies with lower wealth discrepancies perform better, at least according to The Spirit Level.
- The ROI on high executive pay in most cases, and certainly on average, is very low or negative (see Searching for a Corporate Saviour by Rakesh Khurana). In plainer terms, higher pay for Execs results in a small number of marginally better outcomes and a much larger number of worse results for shareholders.
- An unregulated market will be distorted by those with the greatest interest in the market – in this case CEOs.
- High pay doesn’t motivate people.
Both sides of this death-match are replete with fundamental flaws.
The problem with the Blue corner is that they don’t tend to argue from an evidence base. They frequently cite singular examples where their principles have ‘worked’. Of course that is one of the very problems with their case. They neither look across the whole market for CEOs nor at the evidence for performance for pay (mostly because they can’t – performance broadly hasn’t matched the massive increase in Exec pay). As a result, they don’t see that the cost of having a CEO is rising out of all proportionality with the results they are achieving. While it may have been true in 1990 (Jensen M. and Murphy K., Performance Pay and Top-Management Incentives, Journal of Political Economy, 1990, Vol. 98), something has changed and it isn’t true now.
It’s also not clear that the Superstar arguments used to justify the salaries of top level entertainers and sports persons can be used in relation to corporate executives. For starters footballers (or basketballers, or whatever other sporting giant dominates the payment of salaries in any given country) are held very tightly to performance in a way that doesn’t seem to apply to CEOs. In fact, the rules about lack of performance that would see any of our sporting stars fired – instantly, and without further pay – seem to be non-existent when it comes to CEOs who have destroyed value for shareholders. The CEO golden handshake is built into virtually all CEO contracts, even if they ‘retire’ in disgrace.
Further, based on the data coming out about education (particularly business graduates) and rapidly rising number of MBAs awarded each year, in conjunction with the law of supply and demand, we should expect there to be an increase in supply of possible Executives. According to that law, It doesn’t make sense that such an increase in the supply of possible executives would result in the sort of increased salaries we are seeing, which suggest a decrease in supply. The increased number of MBA graduates contra-indicates a very large increase in supply. So the very market mechanisms that high paid Execs are using to justify their salaries are undermined by the very economic modelling they advocate (or the raft of B-schools providing such education).
BLUE-ists constantly ignore Jeroen van der Veer, formerly the Chief Executive of Shell, who said:
“if I had been paid 50% more, I would not have done it better. If I had been paid 50% less, then I would not have done it worse”.
But surely you don’t think I’m going to stop there. There’s a dichotomy to cast!
The problem with the Red corner is that they don’t tend to offer solutions to the problems they highlight. Stakeholders barely have any connection with corporate performance or, in particular, the challenges that company management have to face in order to deliver quarterly profit reports. Further, stakeholders have almost no legitimate means by which to exercise their views. After all, their opinion is just one among many that management need to consider.
They also aren’t providing any alternative calculations by which pay-for-performance can be appropriately calculated, nor how a company (or an interested government) can appropriately cap pay to some kind of minimum, whether that be the lowest paid worker or some other benchmark. Or if they are, they aren’t able to accurately identify the breaking point between the success and failure of the Blue Corner.
But the boxing analogy just doesn’t work. [Cue to close up of the announcer, tight on his blank face; pan back and tilt to show he is standing alone in the ring, crowd gone home, with the high-spec microphone being slowly and jerkily reeled into its mysterious home in the roof – the announcer shuffles, looks at the camera, adjusts his feet and turns toward the back of the ring]
One of the real problems with trying to pit Friedman against Freeman in the title fight for supremacy on the issue of Executive Remuneration is that both of them end up looking like parodies of themselves. Strange beings that are absolutely committed to their ideals only for their sake, and in spite of evidence that contradicts their respective positions. No-one seriously believes (or no-one that you ought listen to unless you figure that you already have too many IQ points) that either of them are right, and so the world looks rather more like a combination of red and blue. The reality lies somewhere in the middle.
But recognising those problems doesn’t magically mean that the solutions reveal themselves. Things get pretty complex when you start to think about resolving the red and the blue. Doubtless there are legislative options that can help, but they are likely to be implemented slowly and not without unintended consequences.
For the Love of Business
And so we need to talk about whether controls on capitalists help us to avoid the sort of social depravity that most of us might expect to see in exceedingly unequal economies. Even capitalists accept that the sort of rioting that we saw in the UK in 2011 isn’t all that good for business. And most commentators agree that the inequity in UK society played a significant part (if not the starring role) in the drama that was the UK riots 2011.
In the UK in 2011, the median wage earner earned the amount of £26,200 (for those of you scratching your head about your 9th grade math, median is the middle number in any set – in this case the middle wage paid to UK earners and the median is much lower than the average). Bob Diamond, on the other hand, is reported to have been paid £17 million for his services. To put that into perspective, it would taken the median wage earner almost 649 years (about 16 working lifetimes) to earn that amount. Almost no analysis (other than a neo-liberal economic analysis) would conclude that such discrepancy is fair or useful.
U2 and CEO-ing
But if we restrict capitalist markets, won’t we destroy the very thing that drives capitalism? Fred Whittlesey makes the point well:
I just read that U2 made $260 million in gross receipts on their 2005 tour. That’s $3 million per show (about $1 million per hour)–far above Motley Crue’s $33 million for a similar number of shows (a paltry $400,000 per show, well under $200,000 per hour). I don’t think most Americans want to impose an arbitrary cap on CEO pay any more than we want to impose a cap on U2’s concert tour receipts because we know U2 would stop touring, and good CEOs would stop CEO-ing, and neither of those is to our benefit.
And that might be a compelling argument if we hadn’t seen U2 doing free concerts and tours on several occasions and giving away their music for free. which means we have to ask – What drives this sort of behaviour? The red corner might argue that it’s their recognition that they don’t need the money and their desire to give something of their wealth back to fans. The blue corner might argue that it’s a gesture of goodwill that will ultimately increase their ability to sell records going forward by creating brand loyalty. I think that something else might be happening.
U2, I would suggest, would do music if they were paid $10,000 per year. Or $100,000 per year. Or even $1m per year … you get the point. They do it because of an innate drive to be good at music. They do it for the love of music-ing. The money is a byproduct. The same sort of logic applies to Radiohead, who released a free downloadable album at no cost and Bjork, who … actually, best not to use Bjork as an example.
Now I’m not saying that CEOs should work for nothing. But I am saying that CEOs don’t, … well … CEO, only for the money. There is an innate drive in them to … CEO-ing (if you catch my drift).
How Execs need to help solve the issue
And I wonder if that is why Execs are happy to tell Grant Thornton about their (anonymised) belief that they are paid too much. I’m not entirely surprised CEOs think that – but I was a little surprised they admitted it.
Just like U2 understand that they don’t deserve the income they earn, some CEOs understand that they don’t deserve the income they earn. Ultimately, I don’t know who is right in the big pay debate, but I’m guessing that we shouldn’t take our steer from the RED corner, nor the BLUE corner. The answer lies somewhere in our desires as individuals and collectively as societies about what we choose to value. Those things run much deeper than simple arguments about pay and have a profound effect on how the rest of us behave and perceive our ability to be a positive contributor to society.
Perhaps it is surprising that it has taken collective action by institutional investors (like insurance companies including Aviva – anyone else see the irony here?) to ignite shareholders into action to restore some balance to Executive remuneration discussions. It’s possibly in part due to action by stakeholders (partly as a result of the focus on CSR), who have said that it’s not bearable for Execs to receive such high amounts of money, but it seems that motivated shareholders are getting the job done in a way that stakeholders may not have been able to achieve.
We need a Hero
The reality is that to tackle the Executive Pay issue, we need business to be sensibly and constructively involved in the debate. And that means that Executives need to stop hiding behind the arguments put forward by the RED corner and start talking sensibly about how we can use Executive Pay to create value, trust and stronger societies. And on the way, it wouldn’t hurt them to go a bit PINK (of the motivation and behavioural economics variety), and tell us that they love their job and would do it if they were paid a lot less. Or at least that they will do a free concert, ah … I mean, year’s service or two. In many ways, that’s what we are seeing when Executives refuse to accept bonuses to which they are otherwise entitled.
It’s also important to echo Carne and Matten in their thoughts on “Solving the executive pay problem“, that we won’t really be able to do anything significant about the issue until we work out which of the several problems (lack of transparency, lack of connection to value-creation, income disparity, etc…) we want to solve. No-one wants to see a revision of the ham-fisted attempts of the US government in the early 1990s to put a cap on Executive Pay.
That means we need:
- a CEO to stand up and recognise that the unintended behavioural consequences of pay for performance are many, and that we need to scale back some of the damage that has been done.
- a Remuneration Committee to say that financial opportunism has played far too big a part in setting the salaries of CEOs.
- and one or more CEO to announce that they will be taking pay cuts.
Hopefully those three things will create an upward spiral of behaviour that will result in more appropriate levels of remuneration.
Of course, Grant Thornton, who offer a suite of services related directly to executive remuneration have a very clear interest in ensuring that they read the shareholder’s tea-leaves right, and now that they know that CEOs know that they are paid too much, perhaps we will see them come up with the next great solution to solve this issue. After all, they’ve been part of an industry that has been complicit (if not active) in driving up the amount we pay CEOs.
Thanks to Elena Espinosa for highlighting this comment by GRETCHEN MORGENSON of the New York Times. Gretchen highlights some research that quietly debunks the myth of transportability of CEO skills. That is, a skill set is very often specific to a particular company, and while the skill set may be transferable within a sector, the evidence is that it isn’t transferable across sectors. To quote from the cited study:
“The peer group is based on the theory of transferability of talent. But we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often, but when they do, they’re flops.”
New Economics Foundation’s report, ‘A Bit Rich: Calculating the real value to society of different professions’
New Economics Foundation’s thought piece, ‘The Ratio: Common Sense Controls For Executive Pay And Revitalising UK Business’
Scott Elaurant article ‘Corporate Executive Salaries – The Argument from Economic Efficiency‘
Final Report of the High Pay Commission, Cheques with Balances: why tackling high pay is in the national interest
Kelson and Ferrere research, Executive Superstars, Peer Groups and Over-Compensation – Cause, Effect and Solution