Big bucks for presiding over decline? It's mad

Anthony Hilton
30 Jun 2009

When everyone is feeling relatively comfortable and securely employed, they are more tolerant of the occasional excess in executive pay.

Because they feel they have enough for themselves, it does not seem to be worth getting overbothered about what is happening elsewhere.

When, in contrast, they are feeling vulnerable and uncomfortable, they put a much greater emphasis on equality and fairness.

They will tolerate the hard times, but only on condition that everyone else does and there are no privileged tickets for the few to avoid the pain.

There is a need for all to be seen to be suffering — if not equally, at least to some degree.

This is not just a tension between the low-paid and the highly paid within a company or society.

It also explains institutional shareholder attitudes to executive remuneration. When share prices are rising, resistance even to egregious executive pay packages is muted.

When investors are losing money, they react angrily to executives overpaying themselves. That is what they are doing at the moment. But perhaps not angrily enough.

By coincidence, two quite separate articles appeared last week on the same page on the same day in the Financial Times which, when coupled together, pose a severe challenge to the assumptions underlying the incentivisation of executives.

The first pointed out that for 50 years or more leading up to the 1990s, the average American business leader earned between 20 and 30 times the average of their employees.

But following the cult of shareholder value and the perception that there was a need to use pay to align the interests of management and shareholder, which started about 20 years ago, the average executive salary is now an almost unbelievable 400 times that of the average employee.

The other article coincidentally explained how little shareholders have got in return.

It quoted research into US corporate performance published recently by Deloitte's Centre for the Edge.

It found that the return on assets at US companies had fallen steadily since 1965, from around 4% to 1%.

Consumers have done relatively well out of the squeeze, benefiting from lower prices. Highly skilled employees have done reasonably well, too. The casualties have been less skilled employees and shareholders.

So although corporate profits in 2006 were at an all-time high as a percentage of gross domestic product, this was a blip at the expense of wages, and it conceals a steady and continuing erosion in corporate performance.

Banking and finance offers an extreme example of this.

Banks appeared to be hugely profitable, and the management took its share with massive bonuses.

But the profits were based not on organic growth but on leverage — taking on ever more risk. When the inevitable crash came, management departed with its money, and shareholders were left facing the bitter truth that they had lost all theirs.

The point is, however, that the same pattern has been repeated elsewhere throughout the economy, albeit less visibly in private equity where the gearing and risk is evident, but also in almost every company that borrowed money and reduced the strength of its balance sheet to buy back its
own shares.

Supporters of the executive pay process — not just senior management but also the whole army of remuneration consultants and headhunters that has grown up on the back of the pay explosion — argue that the corporate underperformance does not mean executive pay schemes don't work.

Without the incentives, things might have been very much worse, they say.

There is no argument against that, though it is surely not what most people have in mind when they talk of performance pay.

But it is surely worth questioning why we have to pay our business leaders quite as much as we do to preside over decline.

It's a bit like Canute — if decline is inevitable, no amount of money in executive pay packets will hold back the tide. So why do we believe it will?

Amusing aside to row at M&S

Personally, I can't get particularly exercised by the corporate governance row at Marks & Spencer, where pressure is mounting formally to separate Sir Stuart Rose's combined job of chairman and chief executive.

It is a bit late in the day, given that he has held both jobs for some time, and is already committed to separate the two roles and move on next year.

It seems a bit contrived suddenly to discover this as an issue, particularly when there is not the slightest bit of evidence that those agitating for change have any coherent idea whom they might like to in charge of the company if he were forced to step aside.

The critics might also ask if this is really the best way to motivate Sir Stuart in his last few months.

That said, what is particularly amusing, at least to me, is that Sir Stuart's position of power is very much a consequence of the support he received when he first came into the company from his then chairman Paul Myners.

Myners is now an elevated figure, Lord Myners no less, and in his capacity as a Government minister is charged with improving - or at least changing - corporate governance across the UK.

How piquant if the first test case of his demand that shareholders engage more actively should be to demolish an arrangement that derives very much from Lord Myners' previous life.