Are chief executives overpaid?

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In October 2018, Deborah Hargreaves published a new book, under the title “Are Chief Executives Overpaid?”. The question, of course, is rhetorical.

Hargreaves is an ex Guardian business editor and FT journalist who has made it her life’s work to attack fat cat pay, which she believes is having a corrosive effect on the cohesion of our society and is putting liberal capitalism at risk.

Hargreaves has been most effective at creating visibility in this area, although I suspect she fans the flames of discord rather than dampening them down. She was the original Director of the High Pay Commission in 2009 which was founded and funded by Compass, the centre-left pressure group, aligned with the Labour Party.  Compass’ mission was to get the Labour Party re-elected, and they figured that dissent over executive pay was a good lever for winning votes.  Mirroring the name of an existing official body, the Low Pay Commission, was a clever ploy.  It gave the High Pay Commission immediate credibility and a quasi-official status.

In 2012, Hargreaves set up The High Pay Centre (the HPC), its successor organisation.  She describes it as an independent think tank, not aligned with any political party, although its spiritual affiliation to the Labour party is evident.

Hargreaves has very firm beliefs on executive remuneration.  She believes it is a manifestation of human greed and is escalating far beyond the pay of the average worker and in a way that bears no relation to company performance.  Current pay differentials are essentially unfair. Chief executives are not worth anything like the amounts they are paid.  She is more sympathetic to entrepreneurs who are people creating wealth through their energy and ideas.  But “captains of industry” are essentially bureaucrats – they administer a system someone else has created. This refusal to believe they add so much more value than the average worker leads Hargreaves to use such ploys as “a captain of industry in the UK take 129 times the annual income of someone on average wages” and the more dramatic statement that before the end of the first week in January they will have “notched up” more income than the average annual wage.

In keeping with those beliefs, Hargreaves’ language is heavily value-laden.  Executives “pocket” their pay. She talks about “late-stage capitalism”. Remuneration governance is a “religious cult”.  Thatcherism was intended to free the “supposed” entrepreneurial spirits in people.

In her criticism of the conspiracy of excessive executive pay Hargreaves takes a swipe at pretty much everyone. US business schools take a lot of stick – principal-agent theory “doing the rounds of US business schools”.  Head-hunters are a “coterie” drawing from the same pool of usual suspects.  Institutional shareholders are too self-interested to act as effective policemen for executive excess. They provide “weak oversight”.  Government crumbles in the face of corporate UK and US. Remuneration committees are afraid of the executives. Former civil servants (in nationalised industries) were “pitched into the premier pay league”.  Remuneration consultants, the “high priests of the religion”, work to create high pay through benchmarking, chasing the upper quartile and opaque and complex incentive design.  Tony Blair and New Labour sought a cosy relationship with big business. Even Joe Public comes in for criticism: “The modern economy has succeeded in turning peoples’ needs (the basic material goods required to achieve a secure standard of living) into wants which are never-ending.”  The puritanical nature of these views indicate an aversion to people earning “loads-a-money” and a desire to produce any argument as to why they do not deserve it.

You can feel sympathy for Hargreaves’ view point.  But what disturbs me is her careless use of statistics to support her case and the willingness of business editors and politicians of all parties to accept these statistics without question.  One notorious piece of earlier HPC “research” served up again by Hargreaves is the report of October 2014, Performance-related pay is nothing of the sort, produced for HPC by the now defunct Incomes Data Services. This was an appalling piece of sophistry: a fishing expedition which showed no real understanding of statistics or maths.  It was full of errors, but one notorious example will suffice here.  IDS plotted executive bonuses against company profit for 350 companies on one chart.  They showed there was virtually no correlation between profits and bonuses on their graph, and their conclusion was there was no relationship between pay and performance. But this was just nonsense maths. I will demonstrate why. Let us say you paid a CEO a share of profits in his or her company and nothing else, there will be a 100% correlation between his or her bonus and his or her performance.  If you accept profit as the measure of performance, his or her pay is perfectly related to performance.  Now If you do the same thing for CEOs in five companies – all paid on a profit share, but with a different profit percentage, the correlation for each company is still 100%, but the overall picture become blurred and the overall correlation falls dramatically.  Graphically, the points are all over the place because the percentage share varies by company.

In fact IDS did this exercise not for five, but for 350 companies, the FTSE 100 and FTSE 250 combined, again making the assumption that profit was a good performance measure. Not surprisingly they found the correlation to be vanishingly small for the sample as a whole.  Does this mean that bonuses bore no relation to profit for these companies?  Of course not: you have to look at the correlation company by company, not the market as a whole– but that is what the IDS study concluded.  They then went on to do the same thing with long-term incentives and relative TSR.  Same conclusion: no relationship to performance.  At the report launch meeting, John Plender, the FT financial journalist sighed with relief “I always suspected this was the case” and heads all around the room nodded.  Since then the canard has been repeated time and again.  David Davis, the right wing Tory MP wrote an essay for the High Pay Centre in which he said “CEO pay has massively outpaced anything with which it can even remotely be correlated”.

Rachel Reeves, chair of the Commons BEIS select committee told the Mail on Sunday the committee is going after the fat cats again later this Autumn.  Their April 2017 report said “executive pay is increasing at a rate that vastly exceeds increases for ordinary employees and which seemingly is at odds with the value created in the company”.  This statement is wrong on both counts – Minerva (formerly Manifest) data shows that, since 2010, CEO salary increases have fallen to a level much in line with the 2%-3% increases in the general workforce and this is has been the case for the past eight or so years.  What have gone up are the earnings from long-term incentives but this is precisely due to share price increases and consequent shareholder returns ie “the value created in the company”.

Does this inaccurate propaganda matter?  Well yes it does.  It becomes accepted as fact and it affects Government policy and inflames public disenchantment with business.

Hargreaves takes another swipe at non-executive boards, who she thinks are not doing their jobs effectively. Then she adds “[FTSE 100] remuneration committee members are well-paid too.  Average pay for a remuneration committee member was £441,383 in 2015 (remember they are part-time jobs), 16 times the average for a UK employee”. This suspiciously precise figure is in fact dangerous rubbish.  The proxy agency Minerva produced an analysis for the MM&K Chairman and Non-Executive Director survey covering 2015.  The average total fees for a FTSE 100 NED was £115,386 (median £94,000).

These figures are accepted by journalists and politicians simply because they want to believe them.

This is from Margaret Hefferman in the FT on 1 October 2018:

“Hargreaves amasses devastating data to prove that performance-related pay massively outpaces all rational measures, and that rewarding failure is routine”.

Powerful stuff, except it is not true.  People want to believe it because they resent the pay for top executives in a way they do not, for example, resent pay for international football stars (Ronaldo and Messi each earn about £40m gross per annum at Real Madrid).

Hargreaves devotes quite a lot of the book to arguing that companies introducing performance related pay fail to understand human motivation.  Executives do not need all this money.  But this misses the point. By blaming executive greed, Hargreaves’s book does not follow through on the real economic issue, which is low pay for the average worker. She blames low wage growth on low investment which in turn she blames on executive incentives with a short-term focus.  She would rather pay the money directly to the workers than increase investment.  She claims to believe in free markets, but doesn’t like it when the market decides some people are worth a lot of money and pays them accordingly.  This jars with her puritanical viewpoint.  Hargreaves ends her book with a menu of actions that could be taken to pull down the share of wealth taken out by top executives:

• Put up top taxes for executives and corporations.  Block loopholes.

• Publish tax returns on-line like Sweden does (the “shaming” approach).

• Move corporate focus away from achieving returns for shareholders towards achieving benefits for stakeholders, especially workers so as to create a new corporate ethos. She (wrongly) claims that the legislation for requiring the delivery of benefits to wider stakeholders already exists in Section 172 of the Companies Act.  (In fact Section 172 requires boards to have due regard for the interests of these other groups, but shareholder interests clearly have primacy.)

• Give the workers a say in bosses’ pay – by a worker representative on the remuneration committee or board (“to inject some common sense”) or even by having a worker’s vote on the remuneration policy.

• Improve companies’ consultation with workers.  Introduce a structure of councils.

• Give the FRC the power to investigate and prosecute company directors for poor corporate governance. Create new statutory bodies in the UK and US focused purely on corporate governance, with new enforceable guidelines.

• Phase out LTIPs.

• Make any bonuses a pure profit share only.

• Pay cash only – no shares.  Executives should buy their own shares.

• Have a binding vote once the non-binding vote falls below 75%.

• Reduce salaries to a reasonable level – all stakeholders to decide what is “reasonable”.

She summarises by saying “a critique of the self-serving justification [of high pay] is often attacked for relying on the wrong data, a misunderstanding of the way companies work and plain old envy.  But if capitalism is not seen to be fair by much of the public there will be moves for something more drastic to replace it.  It is time for the business sector to listen to the moderate voices for reform or reap the consequences of growing inequality, anti-business sentiment and possibly more dramatic clashes. If it does not rise to the challenge, the fundamental trust that makes a liberal market democracy function could be damaged beyond repair.

In fact there are only a few companies with the excessive pay arrangements this book is railing against.  Hargreaves’ proposals would result in a regime which would restrict legitimate reward and damage companies generally, without helping in any way to address the key problem, which is low wages.

For further information contact damien.knight@mm-k.com

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