Solving the executive pay problem

The idea that executive pay can be "too high" is a touchy issue. While many regular Joes are seeing their jobs disappear, or have been forced to endure cut backs to salary and benefits, CEO pay continues to escalate. Bonuses in the financial sector - never popular among the general public - are largely back to their stratospheric pre-crisis levels, much to the chagrin of the tax payers who funded the bailouts that kept them in business. And there is the growing chasm between those at the top and the bottom of the pay ladder that helped galvanize the Occupy movement. According to one recent study, the gap between CEO and average U.S. worker pay was 325-to-1 in 2010. In 1965, it was 24:1.

The business community, of course, continues to argue that it should have the right to determine its own remuneration levels. The global market for executives, they say, forces them to offer high salaries to attract the top talent. But stagnant performance is prompting many to question the logic of that argument. Why should companies be rewarding top executives for failure when everyone else is tightening belts?

Unsurprisingly, regulators have started talking tough. But progress has been limited. Three years ago President Obama announced that he would cap the salaries of executives of companies in receipt of TARP balilouts, yet by 2010 could do nothing to stop those companies awarding huge bonuses, judged to be "ill advised" by his newly appointed pay czar. A more systematic approach was promised with the Dodd Frank financial regulation, but efforts to rein in pay have had limited success. After much sword rattling from senior British politicians, the announcement by the UK government on January 23rd of a new approach to regulating executive pay claims to be the start of a more concerted response to the problem. The trouble is, it is not a very convincing solution. And perhaps even worse, it is not at all clear what the problem really is that they are trying to solve.

The "problem" with executive pay is that it is in fact a whole set of related problems. And each of these require different types of solutions. Income disparity between high and low earners is one thing, whereas CEOs being rewarded for poor performance is quite another. Setting the pay of bailed out businesses is yet another. And so on.

Regulators have to work out which of these problems they are trying to solve and what the best combination of regulation, encouragement, incentives, and sanctions should be to achieve desired results. Take the problem of pay disparity and those troubling pay ratios.  Blunt regulation probably isn't going to be very helpful here. For a start no one really knows what the "right" ratio should be. A maximum permitted ratio of say 100:1 may be feasible in some industries, less so in others. And as many have pointed out, the unintended effects might be that companies start outsourcing any of the low wage jobs they still have to generate a lower ratio.

Incentives, such as tax breaks for companies reaching certain thresholds, may offer more potential, although it would be technically complicated to administer effectively. A pay-ratio credits type market could also be devised whereby those companies failing to meet their targeted ratio could buy credits from those that over-achieve theirs. Much like in carbon markets, these types of systems help to even out differences across industries.

The "transparency" option trumpeted by the current UK government speaks to a more typical way of government providing the framework for corporate social responsibility initiatives. In creating a mechanism for pay ratios to be compared across companies (such as through mandatory reporting of pay, and support for some type of league tables comparing performance) governments can spur companies to improve their ranking. This avoids any necessity of setting limits or levels of acceptable performance and instead relies on competitive forces to drive improvements. As with all these incentives type approaches, it remains up to companies themselves to determine how to improve their performance, whether through increasing the remuneration of lower paid workers or decreasing that of higher paid executives. It stops regulators getting directly involved in setting pay limits and enables businesses the freedom to determine what works best for them from a competitive point of view.

Of course, there are also other less direct ways to encourage better pay equity. George Monbiot the UK journalist and environmental campaigner has recently put forward a spirited defense of a "maximum wage". Others argue for incentives or regulations to encourage increased employee share ownership among the lower paid. Such initiatives avoid the risk of companies simply "gaming" the pay ratio statistics, but also run into other problems, such as resistance from the business community and difficulties in implementation. Still, there is plenty of scope for interesting and imaginative ideas to help solve this and the other executive pay problems, and the UK in particular seems to be at a crucial tipping point in terms of public support for change.

Where the current UK government's proposals largely fall flat is in their over-emphasis on enhancing shareholder control of executive pay. For a start this does nothing directly about pay equity (which is what the public wants) but rather focuses more on the problem of whether senior executives are being rewarded for poor performance. Whilst giving shareholders more input into executive pay is not a bad thing, first you need to have shareholders that are active participants in the companies they invest in. In our dispersed ownership model of financial capitalism where shares are often held for matters of minutes, hours, and days rather than months and years, we often simply don't have sufficient shareholder engagement for such initiatives to make all that much difference. Similar rules imposed by the Dodd Frank Act in the US have done little to curb executive pay.

Clearly the time is right for action on the manifold problems of executive pay. But for those seeking to tackle them, whether in industry, government, academia, or civil society, it is imperative that there is clarity on which problems are going to be addressed. And dealing with such complex issues is going to require more creativity in terms of solutions, and more joined-up-thinking in terms of the causes of those problems, than we've generally seen so far.

Photo by GDS Infographics. Reproduced under Creative Commons Licence

Economic crisis (again) – how do we get out of the mess?

Finally he is back. Bill Maher’s new season of ‘Real Time’ started again last Friday. He is one of the funniest guys on TV in North America right now, and certainly one of the smartest. The first show this season was all about – yes – the economy. Could you have imagined that in normal times? ‘The economy? On a comedy program??’ But here we are.

The show started off with reminding us that the crisis on Wall Street is just about to unravel, we have just seen the beginning. ‘Skank of America’ or ‘Shittybank’ (BM) are still close to the abyss, despite the earlier $700bn bailout. The central contention of the show was this: should the government be involved with another bailout, or should we just allow the system to collapse. After all, this is America, the home of the free market and individual liberty. Let the market sort it out, so Ron Paul on the show.

That didn’t go down well with the other guests. Crystia Freeland, North America Editor of the Financial Times, wasn’t having any of it. Her best comment was that since the bankers of the private sector had failed on such a megalomaniac scale, putting government bureaucrats in charge could certainly not make things worse, hopefully even better. Could you have imagined such a benevolent statement about government involvement in the economy from a Financial Times editor a year ago?

It was fascinating to see how ethical issues dominated the entire program. Congresswomen Maxine Waters, another guest, made an interesting suggestion: there should be the ‘Nuremberg trial for bankers’! That, however, was at least more realistic than Bill Maher’s very funny black humored piece on just ‘hanging’ two bankers, you know, symbolically. As they did in China with the managers who caused the milk scandal some months ago. That might teach these Wall Street guys a lesson…

It is a time of deep navel gazing in America and beyond. Bill Maher’s suggestion was that the last years have given rise not to the ‘American dream’ but rather to the ‘American fantasy’. What happened was not the pursuit of happiness through hard work which makes dreams come true but luring people into the illusion to raise their standard of living based on money that didn’t exist. And he concluded: ‘There is a difference between a fantasy and a dream. Boy do I know!'…

Bailout – Who’s next?

So, you know by now that a little ‘Obamania’ has also infected Crane and Matten. But why not enjoy the honeymoon while it lasts. It might be over sooner than later. Among the many daunting tasks the new administration will have to face – the economy, Iraq, Afghanistan, Guantanamo, foreign relations – one of the most difficult animals for Obama to tame reared its ugly head last week: the American auto industry.

Now it makes perfect sense that at a time when Washington is handing out blank cheques to troubled banks, Detroit’s CEOs thought it worth a try to get next in line. And in fact their companies are in dire straits. Poor quality, fierce competition from the Far East and Europe, bad environmental performance of their products, high healthcare costs – these are just some of the issues which have led to the current situation. None of which is really new and good management could have addressed these problems years, if not decades ago.

But the appearance of the CEO’s of the big three on Capitol Hill last week points at a bigger issue Obama will have to face. It is good to see this in a broader context and to pull Stan Luger’s brilliant analysis of ‘Corporate Power, American Democracy, and the Automobile Industry’ from the shelf again. The book analyses the influence on political decision making by the US car industry over most of the 20th century. It puts the recent efforts of the industry in the context of longstanding direct political intervention, lobbying and coalition building.

Last week’s events then point to one of Obama’s biggest challenges, to deliver on bringing ‘change’ to Washington. And for a democrate President, this is no easy task. After all, car companies still are massive employers. Michael Moore’s ‘Roger and Me’ showed years ago what happens to towns in America’s industrial heartland when car companies close shop. In that sense then Obama’s success will in some way depend closely on creating jobs – which in fact is one of his big promises.

Here is the tricky bit: the political power of business in modern democracies is more than just lobbying or other ways of direct influence. In his book (p. 25) Luger quotes the sociologist Claus Offe on this point:

‘The entire relationship between capital and the state is built not upon what capital can do politically via its association […] but upon what capital can refuse to do in terms of investment.’

So every politician needs business to thrive and to invest in order to secure jobs and tax revenue. To deal then with this crucial contribution of business from the political end is a much more complex job for Obama than it seems.

In this sense, with the bailout of the banking industry and potentially others we might witness a watershed in contemporary capitalism: a return of the government as a key player in business. The last three decades have seen the exact opposite with most governments privatizing large parts of the public service delivery and divesting from their business interests. In some ways the bailouts then might even have this one positive effect: corporations apparently have such an importance for the wellbeing of a society that the government has to ‘rescue’ them in a situation where their survival is threatened. Acknowledging this, and granting the government a controlling stake in these companies might actually reverse one important trend of the last years. Rather than accepting a growing influence of business on politics we might actually see the reverse: that we as citizens, represented by democratic governments, regain control of a corporate world which for too long has put shareholder’s and manager’s interests ahead of many legitimate interests of wider society.

Now that sounds a bit like a utopia. And the perspective of more governmental influence on corporations will make most hard nosed business people cringe – isn’t that what socialism was about? Not quite – but anyway: it is essentially what banks and automakers in the US and elsewhere are currently asking for!