08 December 2016
Draining The Remuneration Swamp
Using sunlight as a disinfectant.
By John Watson
That part of the Government’s Green Paper “Corporate Governance Reform” which deals with excessive remuneration makes rather depressing reading. Although it manages to identify the main issue easily enough, it is much less successful in finding a solution. That is because the problem is a very intractable one.
Let’s start with a figure, the average pay package for the chief executives of FTSE 100 companies (broadly, a company is FTSE 100 if it is one of the hundred biggest quoted on the London Stock Exchange). In 1998, that average was 47 times the average pay for a full-time worker. That sounds an awful lot, doesn’t it? But wait for the next bit. By 2010, it was 132 times. Phew! Thank goodness that it had dropped back to 128 times by 2015. We must be thankful for small mercies. Could anyone really bring enough value to justify that ratio?
The answer to that question is “yes”, but only sometimes. Suppose your ace retailer really can turn round a failing £100 million a year business. Suppose he is the only person with the vision to get an edge over the competition. In that case, like the star footballer who can score the winning goal or the great actor who will turn the otherwise mediocre film into a hit, he is going to be very expensive indeed. In fact you will probably have to pay him just a little more than what he would be worth to any under-bidder.
The amount paid to a star performer will seem a lot to those who do not share his talent, but it was ever thus. The Duke of Marlborough was given Blenheim Palace for his efforts. How many times the pay of a private soldier, or indeed an average officer, was that? What value could he possibly have added that made him worth such an astonishing bonus? Oh yes, he saved the Austro-Hungarian Empire from Louis XIV and, with successive victories, placed limits on French power. No one else could have done it. Hmm, it was cheap at the price when you really think about it.
But what about those who are not star performers at all, who do not add value? No, I do not mean the ones who are expected to turn the business round but fail (their employment is merely a misjudgement by Management) but those executives whose roles could in truth be performed by others. Obviously, businesses should be paying them the market rate for their services, a rate held down by the fact that others would be happy to do the work for the same amount. Yes, that’s the theoretical answer, but do things really work like that? How is the downward market pressure applied in practice?
As pay cheques are met out of the profits of the business, the task of controlling it is primarily one for the owners. That is fine in a small company where the shareholders are directly involved and can see who does what. How though does it work in a quoted company where the shareholders are not involved in the business itself and are probably institutions which manage other people’s money or pension funds?
Here, control of the remuneration is likely to be looser for a number of reasons. The first is that institutional investors are understandably reluctant to upset the executive team which is entrusted with the big decisions. Try telling a dour Scottish Insurance Company that they should interfere with the decisions of incumbent management and you will get a very dirty look. The look will be even dirtier if your proposals might upset the balance of the team which they rely on to generate returns for their policyholders. Second, the amount paid to executives is often small change in the case of a really big business, and institutional shareholders regard it as an unimportant distraction. In business terms they are probably right, but for a public and a government committed to social inclusiveness, with an agenda which can be damaged if mediocre people are seen to be over remunerated, that is not quite good enough as an answer.
So what should the government do? Reforms which came into effect in 2013 already force quoted companies to put their pay policy to shareholders every three years, a policy backed by a system of advisory votes at Annual General Meetings. This could all be further refined, and indeed the Green Paper makes suggestions for doing that. The trouble is that using shareholders to place excessive pay only works to the extent that those shareholders and the public have a common interest. In the case of large companies the overlap is often limited.
Who else could be used then? The Green Paper contains provisions for involving representatives of employees and other stakeholders in the management of the company. The Government has stepped back from Mrs May’s original idea of a requirement to put employee representatives on boards, but various other forms of participation are canvassed. Still, why should employees be any more interested in how the chief executive is paid than the shareholders who ultimately meet the bill? Because elements of the workforce are jealous, perhaps? That is hardly the best emotion on which to base the running of large corporations.
Then there is the government itself. Executive pay could either be limited by statute or could attract higher tax rates above particular levels. The trouble with this is that it throws the baby out with the bathwater. Although nobody would mind seeing those who receive excessive remuneration for a mediocre input being heavily taxed on it, what about those stars we were talking about earlier? Legislation would be too blunt an instrument to distinguish between the two cases, so however enticing an 80% tax rate for executives above a particular level of uselessness might sound, you would end up taxing the truly talented at above international norms. That is probably not a very good idea as we try to build the economy up going into Brexit.
Perhaps, though, there is another approach. The work of the Public Accounts Committee on tax avoidance spawned a great deal of legislation. More importantly, though, it changed public perception as to what was acceptable. If, today, you were to try to market the sort of tax schemes which were in common use ten years ago, you would find that, quite apart from questions as to whether they worked, people would reject them on the basis that they were not quite respectable. It was the great American judge Louis Brandeis who referred to sunlight as the best of disinfectants and shining the light upon tax avoidance has worked well as a way of “draining the swamp”. Could we do the same for excessive remuneration?
A mechanism for making information public is already there. Immerse yourself in the heart-stopping prose of the Large and Medium Sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 and you will find that quoted companies already have to supply extensive details of directors’ remuneration. Perhaps the scope of these rules needs to be tweaked or extended: perhaps it does not. The important question is what use is made of the information after it has been published. If it is merely a tool for shareholders to exercise their rights, an opportunity will have been lost. If, however, it is used to shine a Brandeis-style light onto who is getting what and why, and if the press passes that information on to the ever prurient public, then we may see restraint becoming the norm, and large sums being restricted to those cases where they can be properly justified.
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