Amygdala

Like the expensive hair gunge you’re encouraged to buy because ‘you’re worth it’, executive pay happens to people who believe that they deserve the very best and are prepared to give it to themselves.

Who sets your wages? That’s right, someone you call your boss. Who sets their pay? Right again. Someone they call their boss. But who sets the pay of the guys who run companies? They do. So it would be amazing if they had exercised restraint and limited their pay rises to the measly few percent you get a year. I mean, if you could give yourself a payrise right now, and no-one was going to cap it, how much would you give yourself? One percent? I don’t think so.

The executive counter of course is that their pay is performance related so executives are being rewarded commensurately with shareholders. This is a lie, but it is a big and politically charged lie, so they get away with it.

In most cases, the performance criteria are so easy (e.g. don’t take account of inflation, of windfalls in foreign exchange or general rises in stock markets or their sector) or irrelevant (e.g. based on topline revenues) or manipulable (e.g. earnings per share) that they guarantee huge payouts without the bosses needing to do anything except turn up for lunch.

In any case, there is no empirical evidence whatsoever that any form of performance-related pay at senior level improves overall shareholder return or any objective measure of profitability. The fact that people, usually Americans who need to believe inequality is a good thing, keep repeating that it works doesn’t mean that it does.

There is also some evidence, for example the failure of the whole European and US banking sector, that performance-related pay creates such a distorted view of a successful business that it cause their destruction. Senior bankers’ pay has risen even faster than executive pay in general, so it is at very least an interesting exception to any supposed rule that high executive pay is good for shareholders.

Even if one could say that performance-related pay could be linked to higher profitability, shareholders would need to be very sure that the performance being rewarded was real. The banks showed us how their profits rose without any understanding of the increased risks being taken to get that growth and without telling anyone that the profits had been brought forward from the future or that all sorts of other accounting oddities had created profits that didn’t exist. How can shareholders be sure in the short term that quarterly or even annual accounts give a true picture of the long-term health of the business? They can’t.

Executives and the recruitment and remuneration consultants who back them up (can you guess why?) sometimes also say that sky-high salaries are justified these days because the chances of being sacked are so much greater. Well, first I’m willing to bet job security is worse at the bottom of the pyramid than the top. And second, in exchange for Bob Diamond’s pay packet over just the last three years I am prepared to be unemployed for life and sign a piece of paper that says I will never claim a penny of benefits. Also, hang on, are all the senior bankers who did such a good managerial job out of that job? No, didn’t think so.

The fact is that the people who get paid the most in the world, whether they are corporate executives, far-left UK union bosses (transport firebrand Bob Crow is on £145,000 a year) or left-wing journalists who complain a lot about executive pay (Guardian editor-in-chief Alan Rushbridger gets almost £500,000 a year), get paid that amount simply because there’s no-one above them to look at what they’re actually worth.

To your boss, you are a real cost. You come out of his departmental P&L against which he is judged and on which he may be paid. So he looks pretty hard at whether you’re doing a good job. But at the very top, the company’s money is just someone else’s money. And we all know how much we care about economizing with that.

The executive riposte is that that is not true, that there is a board and a remuneration committee and then the shareholders themselves sitting in judgment and acting as a restraint on rewards. That is a technical argument and there is a technical response: bollocks.

First off, given the fact of the pay rises, this is just not true – there has been no restraint. Second, there’s no reason for it to be true. A board is, when it comes to pay, a group of porkers around a trough. It takes a crazy pig to harangue his fellows for the collective gluttony and it takes a truly unhinged head pig not to stuff his more junior colleagues to the gills to dissuade them from questioning his own eating habits. 

But what about the shareholders? Why don’t they intervene as it’s their wealth that’s being siphoned off? Well, there’s the rub. It’s not.

Most stocks are held by asset management companies. You know, the guys that get you into every trend right at the point it’s no longer your friend by sticking those huge posters up at your station. The ones with the photos that imply that if you save £50 a month you can retire to Petit St Vincent when you’re 43. (This was true for anyone born on a Wednesday in 1946 but the rest of us will be working until we’re turned into fertiliser for Brazilian soya growers.)

These guys mostly take a percentage of the total amount of money they manage, so all they care about is marketing: the more they can sucker you and your fellow commuters into investing in the new new thing (tech stocks, property funds, gold), then the more they make. Since they spend most of their time losing your money once they’ve got it, they have an endless appetite for more.

This means that they are paid like bankers: they’re paid on volumes not quality and because they aggregate lots of little pieces of cash into big pools, when they get a percentage of something it’s generally a huge amount of money for an individual while remaining tiny compared to the size of the business. This is why they don’t complain too hard about executive pay.

But the fundamental reason they have no incentive to complain is that they buy shares with your money, not theirs. The cash that fills equity funds is the pensions and savings of millions of average Joes. So when fund managers buy stocks, they’re not risking anything of their own, which is what a real owner does.

And that is the nub of the problem. The senior executives of publicly-traded companies act as owners and are paid as owners when they are nothing of the sort. The guy who truly owns his network of garages or his machine tool business is rightly free to pay himself what he wants and can rule his empire as he pleases. It’s his money, his assets and he built it himself. If it goes wrong, he personally goes bust. If it goes right, he personally becomes very rich.

Our system of capitalism tries to replicate that model in public markets where it doesn’t work because no-one accepts the risks of being the true owner of a business, but everyone tries to get the rewards. Boards pay themselves in every way as an owner would, but don’t go personally bust if the company goes under. If pushed they start mumbling about only being the stewards of the company for the real owners.

These “real owners”, the shareholders, each own minority stakes and have no power to alter management or its pay unless they all get together and agree and vote, which is difficult and costly. Imagine if you and 40 other people co-owned your car. Would ownership be of any value and would you still consider yourself an owner or just someone who’d lost control of their location?

In any case, what kind of ownership should they be allowed to exercise? Bitter, overpaid old lefties like Polly Toynbee are correct. Institutions do not treat the shares they own as slices of ownership in a real business. But how could they? A fund manager in Edinburgh who owns 3% of British Airways is hardly in a position to make business decisions about running an airline even if his stake was big enough to allow him to.

Shareholders also only lose what they’ve invested in the stock, they’re not liable for the debts. The banks or debt holders get lumbered with those, but they have no voting rights, so aren’t like owners either unless the business does go bust in which case it’s a bit late. (The market is supposed to help here by giving lenders owner-like powers . Debt should be hard to find for bad management and so lenders should be able to twist arms behind the scenes. It may have become apparent in the last few years that this doesn’t work, especially if governments are as incompetent as bankers.)

To be fair to the shareholders, they also don’t get the rewards of ownership like the managers do. First, the market is not a good reflector of underlying value, so even if things are going fine but everyone hates oil stocks, you lose. Second, The asymmetry of many owners few managers means that good performance is diluted across all the shares into a few points of gain while the managers’ profit shares double. This contrast between real individuals becoming multi-millionaires in a year and institutional shareholders simply posting a slightly better fund performance is at the heart of why the system works the way it does.

So in reality “ownership” is so fragmented and diluted by the number of owners, by capital structure and by the fact that the ultimate winners and losers (you and I) have no say, that it does not exist. In its place you have management acting as owner, squatting in the townhouse and spending the rent as it pleases.

This may annoy you, and it might make you question the entire foundation of our society, but is it any of your business? After all, if you really don’t like it you don’t have to buy shares or allow anyone to do so on your behalf. Yes, there is the social  argument but that is tantamount to a demand for communism: if you don’t like corporate executives being paid so much, because inequality cause social problems, then you need to cut all oversize pay packets down to size including those of BBC bigwigs, quangocrats, Guardianistas and also entrepreneurs who’ve built their own businesses from nothing without any help from you. Where do you stop and how do you do it? Who decides who deserves what or is there just a blanket cap?

One thought though: big, publicly-listed companies benefit from limited liability. When companies go bust and management retires minted, the banks lose. When that happens a lot, taxpayers have to bail out the banks. The taxpayer in a capitalist society has written an unlimited guarantee to corporate management that lets it off the hook for infinite incompetence at the same time as omitting any mechanism for control or oversight. Expecting management not to bet the farm while helping itself to the cream of the crop is therefore bonkers but it’s your fault.

So if you view this system as a gift from the taxpayer, then demand a quid pro quo. Ownership is where the buck stops, it’s the answer to the question., ‘who is going to pay this bill?’.  The guy who pays the bills deserves outsized rewards and no-one else. That person is you. If you can think of how to do that without screwing everything else up, then you should probably start a new political party. Unfortunately, that’s, like, too much like hard work, isn’t it?