Why didn't investors stop high executive pay?
- 9 January 2012
- From the section Business
There is something of a cross-party consensus that giving shareholders stronger powers to veto executive pay deals would help to curb the excesses of executive remuneration.
But in some ways this trust placed in the owners of businesses is a bit odd.
A decade ago shareholders were given far more information on executive remuneration deals, and the right to vote on executive pay policies, and it is only since then that the issue of executive pay has become the resonant symbol of perceived social and economic unfairness.
Admittedly it's really bankers' pay that has been most contentious - the notion that they scooped massive rewards in the boom years and transferred the losses to taxpayers and the wider economy after the 2008 crash.
And, as has been well and widely documented, shareholders did nothing to prevent bankers taking their reckless risks to boost profits and pay. In fact, there is a fair amount of evidence that they encouraged banks to lend and invest far more than was prudent relative to the capital that's supposed to absorb losses.
What's relevant is that investors, like executives, had something of a one way bet. If all went well, bonuses rose for execs and dividends rose for investors.
As and when it all went wrong, the worst that could happen to the bankers was they could lose their jobs. For the shareholder, the worst that could happen was that the share price could collapse to almost nothing.
To put it another way, for bankers and shareholders losses were capped or limited, but profits were in theory unlimited.
It was taxpayers who were exposed to the vast bulk of potential and actual losses: they (we) had to provide equity capital and credit to these vast financial institutions to keep them afloat, because the economic consequences of doing otherwise were unthinkable.
Now let's be absolutely clear about this: shareholders had the power to force banks to behave in a more prudent way.
There is no evidence that it would have made a fig of difference whether they had a formal veto power over pay deals - which is what the prime minister is now recommending as the centrepiece of executive pay reforms.
To repeat, shareholders have for years had the right to vote on listed companies' pay policies. The fact that these votes didn't formally bind boards was irrelevant.
The point is that many company directors have said to me then and since that if shareholders voted in large numbers against the so-called remuneration report, that was the kind of massive embarrassment that would bring about serious change.
And, except in very rare cases involving companies other than banks, shareholders almost never registered protests against executive remuneration in this way.
As I mentioned yesterday in my post (Will shareholders crack down on executive pay?), for most numbers of shareholders, the pay of executives is an almost irrelevant issue. If they're not planning to hold the relevant company's shares for more than a few months or even a few nano-seconds, why should they agonise over how much the boss of Megabank is likely to pocket in three years or five years?
There's also a more insidious factor, pointed out to me yesterday by a fund manager who looks after vast amounts of other people's wonga (it might be your wonga, if you're saving for a pension).
The point is that the earnings of people like him, who manage our savings, are even less transparent than those of company executives.
So his boss, he says, has a pretty big personal incentive not to make too big a fuss about how much and how corporate directors are paid, because someone might at some point start a campaign for greater disclosure of pay practices in the very highly remunerated fund management industry.
The consequence of this lack of reasoned open debate about pay may mean that everyone ends up losing.
Here are the terrifying statistics about one of the mad consequences of all this.
According to research by Manifest/MM&K and cited by the government, FTSE100 remuneration rose fourfold - from £1m to around £4m - over the past dozen years while the share prices of FTSE100 companies typically failed to rise at all.
Or to put it another way, if profits at FTSE100 companies increased in this period, all the rewards went to the managers rather than the owners - and of course the owners included millions of us saving for a pension.
I suppose this allocation of the spoils to senior directors would be less contentious if the rest of the population benefited through much higher pay too, even as their pension savings were squeezed.
But to quote from a Business Department discussion paper, "over the last 12 years employee earnings have grown 4.7% on average per year compared to 13.6% for FTSE100 chief executive officers".
Which means that employees in general saw their living standards rise, but at a rate that was two-thirds slower than those at the apex of corporate power.
And that gap between bosses and the rest has been widening, on most measures.
In these low-growth times, with the economy teetering on the brink of recession, official government data puts the increase in typical or median gross annual earnings at 1.4% to £26,200 (that's for the year to April 5 2011).
Gruel too for FTSE100 bosses?
Well, over the same period, the "average" pay of FTSE100 executives rose 49% to £2.7m according to Incomes Data Services.
Actually that's probably not the right comparison: the increase in so-called average bosses' pay probably gives too much weight to the more extreme pay settlements.
Better instead to use the rise in median or typical pay.
So that 1.4% rise in most people's earnings is probably more appropriately contrasted with a 14% rise to £2.6m in the median total remuneration received by FTSE100 chief executives, or a 12% rise to £3.8m in the remuneration package they were awarded, as measured by Manifest/MM&K.
To put it another way, bosses' pay rose around 10 times as fast as most other people's pay - and the ratio of their total remuneration to a typical person's earnings is at least 100 or as high as 150.
It may well be that the least worst system for running the economy involves those at the top earning more and more relative to the rest of the population.
But if the vast majority of people decide that at least some of the spoils going to company directors are unfair, then - rationally or not - they may decide they don't want this least-worst system any more.
Which is why many members of the government would argue that it's in the bosses' selfish personal interest to conspicuously show more pay restraint, so as not to kill the goose that has been laying those enormous golden eggs for them.