Source: The Economist
Executive pay levels rise because of globalisation, not poor oversight
HARD work builds character, and should be rewarded. But many Britons believe the link between graft and gain has broken down. At the bottom, they see a dependency culture that costs them billions in welfare spending. At the top, pay for executives seems to soar regardless of the fortunes of their businesses.
Even some on the right are rounding on corporate excess. David Cameron, ever alive to the public mood, announced on January 8th that he would reform executive remuneration. His ideas include giving shareholders binding votes on the pay, perks and severance packages handed out by companies. Vince Cable, the Liberal Democrat business secretary and perhaps the most left-wing member of the coalition, is leading the raid on boardrooms.
Ed Miliband, the Labour Party’s increasingly criticised leader, wants to go even further. He argues for putting workers’ representatives on company boards and making corporate pay more transparent. Labour is the party of equality, yet the issue is a bind for him. If he is much more radical than Mr Cameron, he risks reviving his “Red Ed” reputation. If he is not, the government’s efforts will grab all the attention.
The debate over executive pay is likely to heat up over the next few months, fuelled by disclosures of bumper bonuses for bosses. The timing will be particularly embarrassing to public companies and politicians, as median real incomes are forecast to fall sharply as the economic slump continues.
Mind the gap
It is true that in Britain, as in many other rich countries, the rewards of economic growth have not been evenly distributed. Chief executives’ pay grew from an average of £1m ($1.7m) in 1998 to £4.2m in 2010, a far greater increase than the average worker experienced (see chart). Measures of income inequality in Britain are close to their highest level since records began in 1961. At the top of the charts are the bosses of media, pharmaceutical and telecoms firms, such as Vittorio Colao of Vodafone Group . Their pay packages are worth more than £7 million a year on average, according to the Institute for Public Policy Research, a think-tank.
The consequence is widespread anger, of the kind that worries governments. Yet the solution British politicians are putting forward to restrain executive pay—strengthening corporate governance—will probably have little influence on it. This is because soaring remuneration has little to do with weak governance and rather a lot to do with globalisation.
Britain’s biggest companies—those in the FTSE 100 index—have gradually transformed from domestically-oriented outfits to truly multinational firms. The skills needed to manage that sort of company are relatively scarce, so those who have them can command higher pay. Unskilled workers in Britain are less distinguishable from those in China or India, and have seen their wages depressed by globalisation as a result.
Yet experience in America suggests that leaving pay to the market does not invariably mean more cream for the fat cats. There, the average pay of bosses has declined by 43% in real terms from its 2000 peak, reckons Steve Kaplan of Chicago Booth business school. The average S&P 500 wage for chief executives is now $10 million. British bosses may simply have been catching up with their American counterparts; the strong upward trend in their pay may not continue.
Moreover, pay increases at the top are widespread. Those running private-equity firms and law firms are paid comparable amounts (as are sports stars). It is hard to pin high pay on shortcomings in the governance of publicly-owned companies.
The government’s aim, to link pay more tightly to performance, is a good one, as is the goal of making pay more transparent. But simple changes would be better than grand reforms. British corporate governance rules are already pretty good, says Carl Rosen of the International Corporate Governance Network, a think-tank. Shareholders have had an advisory vote on pay for ten years and can sack members of pay committees if their advice is not heeded. If there is weakness, says Mr Rosen, it is more likely to lie in the increasingly fragmented and international character of shareholders (who may not care much about who is paid what) than in the powers they have. Giving shareholders a binding veto sounds impressive, but shareholders might be less willing to exercise it than an advisory vote. There is also scant evidence that putting employee representatives on pay committees yields better results.
The idea that pay should be restrained ultimately rests on a flawed logic. Income inequality is best addressed by closing the skills gap in the workforce, not by preventing British firms from competing for the best chief executives.