Top Dogs and Fat Cats
This new book from the Institute of Economic Affairs was published on 8 May 2019. It is a collection of essays on executive pay, providing fascinating insights into the nature of high pay and making a compelling contribution to one of today’s most contentious issues.
The book is edited by Professor Len Shackleton of the University of Buckingham who has written the introduction which provides a critique of the top pay debate and summarises the individual contributions to the book. He has also personally contributed an article on the consequences of “getting tough” on top pay. The contributors are a mixture of academics, practitioners and leaders of institutions.
Below is a synopsis of each contributor’s essay.
Why free marketeers should worry about executive pay
Why free marketeers should worry about executive pay, by Luke Hildyard, Director of the High Pay Centre. The HPC has a view that the greed of executives in large corporations has led to ever increasing pay differentials which are unjustifiable and damaging to society.
This article begins the discussion by setting out the indictment against excessive CEO pay. Hildyard points out that executive remuneration in the UK has risen far faster than that of ordinary workers in recent decades, and claims that this has occurred without any corresponding improvement in company performance. He dismisses the idea that international competition for rare talent justifies high CEO pay, pointing out that most firms promote their CEOs from within the company. His analysis suggests that long-established successful businesses (as opposed to entrepreneurial start-ups) are built on effective organisational systems rather than the abilities of the current incumbent CEO, who therefore has in many cases little influence over a company’s success. He draws attention, too, to elements of ‘crony capitalism’ that give many big businesses protected markets through their strong links to government.
Hildyard suggests that the ultimate providers of capital – the beneficial owners of company shares – would like to see more modest levels of executive pay, but they are separated from the operation of corporations by a web of financial advisers, asset managers and pension funds. These intermediaries are themselves highly paid and see no problem in paying company executives generously.
Listed companies are required to have remuneration committees which are independent of the company’s management structure, but members of these committees are themselves well-remunerated, are from similar backgrounds to company executives and often hold, or have held, executive posts at other companies. The committees are advised by consultants who (he claims) devise complex remuneration schemes to justify their existence, and act to bid up pay.
In Hildyard’s view, this unsatisfactory situation is undermining the case for capitalism. Free-marketeers should be worried about this, and he supports reforms including worker representation on boards and remuneration committees, more detailed disclosure of pay structures and a requirement for institutional investors to consult ultimate beneficiaries on pay issues.
Understanding the facts about top pay
Understanding the facts about top pay, by Damien Knight and Harry McCreddie, of MM&K. This essay draws from the findings of a previous article we have published in our e-news. The text of the article can be found here.
The right and wrongs of CEO Pay
The right and wrongs of CEO Pay, by Alex Edmans, Professor of Finance at London Business School. Drawing on his own and others’ academic research, he demolishes a number of myths associated with the case against CEO pay. For example, he shows that, contrary to popular belief, CEOs who perform badly do suffer financially – though he points out that it is their wealth rather than their income which is affected, because much of their remuneration is in company shares and share options which lose value with poor performance. While Edmans believes strongly in the reform of company pay, he argues that disclosure of CEO/average pay ratios (a feature of the Government’s policy) can lead to inappropriate conclusions and have unintended consequences which may harm workers. For example, firms may outsource low-paid work to improve their showing. Edmans argues that reform efforts should focus on the structure of pay schemes, rather than the level of chief executive pay. Current pay schemes are complex, opaque and encourage short-termism. In particular, he argues that the use of LTIPs (Long-Term Incentive Plans) allows for ‘gaming and fudging’. He advocates instead that pay should simply be in cash and shares with a long holding period. If shares can at the same time be awarded to employees, they will gain in line with CEOs, which will help address concerns about fairness.
What conclusions can we draw from international comparison of corporate governance and executive pay?
What conclusions can we draw from international comparison of corporate governance and executive pay? by Vicky Pryce, Chief Economic Adviser at the Centre for Economics and Business Research. In her chapter, Vicky Pryce examines high executive pay in an international context. She points out that the phenomenon of rising pay for top executives is found in many countries, not just in the US and the UK. In continental Europe she highlights Germany. Large German companies are often held up as a good example of corporate governance, with wider stakeholder interests, including employees, represented on supervisory boards. Many British commentators argue that such representation will tend to inhibit excessive pay awards.
However, as Pryce points out, CEOs of some leading German firms are paid extremely generously. She puts this down to the need to compete for international talent. Pryce also notes that, while the make-up of remuneration (the mix of salary, bonuses, shares and share options and so on) seems to differ in different parts of the world, high executive pay is also becoming a feature in Asia and Africa. She further points out that in some countries, for example China, recorded pay may understate the advantage executives enjoy from employment, as they also have access to a range of other benefits.
Pryce notes that there is considerable opposition to excessive executive pay in many countries, although opinion polls suggest that antipathy is, perhaps oddly, rather less marked in those countries where executive pay is highest. Governments have been inhibited in their responses, she suggests, because they are concerned that precipitate action might produce little gain. International cooperation might encourage them to overcome their scruples, but so far this has been limited to some minor European Union initiatives.
Two kinds of top pay
Two kinds of top pay, by Paul Omerod, an economist, author and entrepreneur, who is currently a visiting professor in computer science at UCL. In his chapter, Paul Ormerod tackles the differing reasons for the high pay received by entrepreneurs, top sports and entertainment stars (which is in his view acceptable) and by executives of large corporations (which isn’t). Entrepreneurs provide a product or service which did not previously exist, and are thus able to secure monopoly profits, at least until competitors produce something equivalent or superior. These high returns (whether in salaries or in personal wealth through share ownership) are a necessary stimulant to invention and innovation. Top athletes, artists and performers possess unusual talents which have been increasingly rewarded in recent decades as advances in communications technology have created worldwide markets for their services. But their highly visible achievements typically require exceptional personal effort and are not subject to great popular resentment. By contrast, Ormerod argues, executive pay has risen for reasons which have little to do with improved performance and exceptional individual effort. Drawing on network analysis, he argues that board opinions in favour of high pay have spread for reasons which defy traditional notions of rational, optimal behaviour. Networks of non-executive directors, management consultants and remuneration experts have in effect facilitated successful rent-seeking by CEOs.
Top pay for women
Top pay for women, by Judy Z. Stephenson and Sophie Jarvis. Stephenson is the David Richards Junior Research Fellow at Wadham College Oxford; Jarvis is Head of Government Affairs at the Adam Smith Institute.
Stephenson and Jarvis discuss the position of women in the top pay debate. While they recognise that women appear to be under-represented among top earners, they resist simplistic explanations in terms of discrimination and victimhood. They point out that the gender pay gap is widely misunderstood to involve women being paid less than men for the same work, when it is rather that men and women do different jobs, or work different hours, or have less continuous work experience. While this is partly the result of different choices and preferences, these are themselves gendered and reflect social, family and cultural expectations which are difficult to change. In an illuminating analysis, Stephenson and Jarvis see the labour market as essentially an ‘information market’ concerning job opportunities and workplace behaviours. Improving the flow of information to women is an essential element in improving employment trajectories and the possibility of higher pay. This may also be an analysis which has relevance to ethnic pay gaps: many ethnic groups are similarly under-represented in high-paying jobs. Stephenson and Jarvis welcome publication of gender pay gap data as a step towards improved information flows, while cautioning against ‘positive discrimination’ policies such as board quotas. The end goal should always be equality of opportunity rather than forced equality of outcome.
Public service or public plunder
Public service or public plunder, by Alex Wild, a Director at Public First, a research and campaign consultancy, previously Research Director at the Tax Payers’ Alliance. Wild opens the discussion on the public sector, where the arguments for limiting high pay are apparently clearer. Wild points out that, particularly taking pensions and other benefits into account, lower-paid workers do markedly better in the public sector than in the private sector. But top earners in the public sector are paid substantially less than top earners in the private sector. However, few public sector jobs are directly comparable to those in the private sector. There are very limited opportunities in the public sector for independent judgement and actions, as politicians inevitably determine broad policy. There is also much less risk for people working in the public sector, as in most cases predetermined revenue comes from the government rather than the consumer. Senior civil servants, local authority chief executives and similar functionaries face many problems, but they do not operate in the same sort of competitive environment as that faced by company CEOs. It is therefore appropriate that they are paid less, though there should probably not be strict pay ratios or upper limits on public sector pay. Wild recognises, though, that the distinction between public and private is not as clear-cut as is often assumed. There are public sector leadership roles which do face competition, and private sector jobs which nevertheless have a close symbiotic relationship with the public sector. Here it may be appropriate to apply different criteria when determining pay.
Are vice-chancellors paid too much?
Are vice-chancellors paid too much? by Rebecca Lowe, the Director of FREER, and liberal thinking think tank, and a Research Fellow at the Institute of Economic Affairs. Lowe enlarges the public/private debate by looking at the specific problem of the pay of university vice chancellors, who straddle the two sectors. As so many people now have experience of university, and there is great concern over the levels of debt which graduates have accumulated, it is not surprising that the pay of vice-chancellors and other key staff has attracted considerable (perhaps disproportionate) attention, with the Office for Students now having a virtual power of veto over the pay of senior staff. Rebecca Lowe examines the issues in her chapter. Lowe points to the considerable range of institutions in the UK higher education sector, and suggests that they should not all be treated the same, whether in pay terms or anything else. She would prefer a formal segmentation of tertiary education as is found in some other countries. She notes that vice-chancellors are not particularly well paid in relation to their counterparts in the US, Canada or Australia, but points out that the roles in different countries may not be completely equivalent. Vice-chancellors are, however, paid reasonably well in relation to other staff in their institutions and Lowe argues against letting pay rip at the top end. While UK universities are less directly dependent on the public purse than they used to be, so long as significant government funding supports higher education it is reasonable that we should have special expectations about the way they are run, and how their staff are remunerated.
Getting tough on top pay: what consequences
Getting tough on top pay: what consequences, by Len Shackleton. Professor Shackleton draws the themes together by considering the appropriate response to calls for action to rein in high pay in UK business.
He looks at various proposals. First Government policies to use “naming and shaming” as a soft pressure for companies to reduce pay – in particular the reporting of the pay ratio between CEO pay and employee pay quartiles (required of quoted companies with 250 or more employees by the 2018 disclosure regulations), and the publicising by the Investment Association of shareholder resolutions which obtain less than 80% of votes at the AGM. The regulations also require companies to report the reasons behind increases in the ratio and explain how the ratio is justifiable. Shackleton is not opposed to these measures, but feels that the majority shareholders will have little interest in them and they could have negative consequences such as outsourcing, delisting or going private, or changing the structure of CEO pay by reducing the proportion of variable pay or increasing benefits.
Next he reviews proposals to put workers on the board. He says that this has not been effective in restraining top pay in Germany and France and Labour Party plans to require one third of board positions to be reserved for employees are as much about introducing trade union influence to the board. He thinks the measure will curb company growth.
He turns to the idea of executive pay caps. Already public sector salaries above £150,000 have to be signed off by the Cabinet Office. The Labour Party is planning a cap on salaries in companies which benefit from Government contracts. Shackleton questions the practicality of this and points out the negative impact for Government procurement.
He believes that squeezing top pay will have a negative motivational effect on middle management, especially in organisations which employ scarce professional skills. It could also have a serious effect on the UK’s ability to recruit top talent from aboard. He points out that in 2017, 40% of FTSE-100 companies were headed by non-UK nationals. The UK and France had less than 10% of top companies with non-national CEOs.
He sees great danger in the general perception that top pay needs to be curbed and a risk that any control will creep into other aspects company management. Governments need to be careful in how they react to populist calls for action, and giving governments the power to fix pay ratios or even pay caps brings dangers which are not sufficiently discussed by those demanding action. He finds it disappointing to see so many of those ostensibly favouring free markets and limited government intervention joining the clamour against high pay.