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

Is Brazil the model?

Happy New Year to the readers of our blog. Today’s installment comes from Brazil. Rio de Janeiro, to be precise. Oh what a city! The weather, the scenery, the music, the dancing, the Caipirinhas, the beaches, the beautiful people - just to name a few things which enthrall every visitor willing to see it. Ah, and not to forget, the Favelas, the crime, the gaping social inequality and the conspicuous presence of military police at every second corner.

Being in Brazil for a relaxing week one can’t help to evoke Michael Lind’s notion of ‘Brazilianization’ as one of the social science ideas which caused a bit of a stir over the last ten years. No, this does not mean free Brahma beer and Samba for all! It rather refers to a pretty somber vision of change in most western societies toward a model that has been commonplace in Brazil for decades now. Here is how Lind defines the B-word:

‘Brazilianization is symbolized by the increasing withdrawal of the white American overclass into its ... world of private neighborhoods, private schools, private police, private health care, and even private roads, walled off from the spreading squalor beyond. Like a Latin American oligarchy, the rich and well connected members of the overclass can flourish in a decadent America with Third World levels of inequality and crime.’ (pp. 14, 215-16).

Such a model is nowhere more visible than in Rio. While enjoying a luxurious day at the Copacabana you may well see the Favelas just a kilometer away, but thanks to armed police, private security, iron bars around every house you don’t need to worry too much. The ‘underclass’ mostly enters this world after dark - during daylight at best as beach vendors or garbage collectors. Other than that, these poor people are a parallel universe largely left to their own devices (though admittedly the Lula government in recent years has done quite a bit to address the gap).

As Lind and others argue we see a similar trend to the weakening, dissolution, or privatization of basic public institutions, be it in healthcare, education, security or transport in many (so-called) developed economies. In our latest book we argue that this retreat of the state and the privatization of what we refer to as basic entitlements of citizens is indeed happening. The interesting thing for us then is that a lot of business ethics, CSR - or whatever you might call it - is actually motivated by this shift. Or if you like – some form of ‘Brazilianization’ in Western societies.

This conspicuous role of companies in addressing those shifts is not at least visible in Brazil itself. Looking at the website of Ethos, Brazil’s leading CSR organization, or googling ‘CSR and Favela’ in fact shows that many companies have actively started to address some of the institutional void and social exclusion in these parts of the Brazilian society. In some ways then Brazil might actually offer some relevant lessons for companies and societies in the West.