Changing the unacceptable face of capitalism
- By Christopher Georgiou
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E-mail China.org.cn, August 31, 2017
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[Cartoon drawn by Zhang Xueshi] |
Embattled British Prime Minister Theresa May, this week, attacked firms who made excessive payouts to bosses "as the unacceptable face of capitalism."
In an attempt to tackle excessive corporate pay levels, she had made a pledge in her election manifesto that executive pay would have to be approved by an annual vote of shareholders. She had also promised to force public companies to include an employee representative on the board of directors.
Shareholders (principals) appoint directors (agents) to maximize their wealth. Incentives are necessary to ensure directors’ behavior is aligned with that of shareholders, and to maximize the efforts of directors and senior executives.
However, serious levels of pay disparity have emerged between CEOs and employees, leaving many questions, such as: Is productivity increased by higher wages and who gets to decide on compensation levels and can the laws of the market be relied upon?
CEO / Average Employee Pay Ratio (Source: Mishell & Davis, EPI.ORG 2014)
U.K.: FTSE 100 (100 top companies LSE)
1998: 47/1
2013: 130/1
2017: 129/1
Chart Ⅰ CEO / Average Employee Pay Ratio in U.K. [Chart made by Xu Lin]
U.S.:
1964: 20/1
1978: 30/1
1995: 122/1
2000: 383/1
2013: 300/1
Chart Ⅱ CEO / Average Employee Pay Ratio in U.S. [Chart made by Xu Lin]
As seen from the charts, compensation for CEOs in the top companies in Britain and America has grown significantly in comparison to that of the average worker. Bosses of the U.K.'s 100 biggest listed firms earned £4.5m on average in 2016.
However, with the announcement of the corporate governance reform package on August 29, it is clear that the PM’s formerly bold plans have been watered down. Due to practical considerations and legal and business lobbying, the reforms are markedly weaker. Some include:
- The U.K.’s biggest firms will have to publish a ratio comparing the pay of their chief executives to the average employee
- Companies will be encouraged to have workers' voices represented on their boards.
- Public companies who face a shareholder revolt on pay will be named on a register – a sort of "name and shame" approach.
Resentment at huge executive salaries is not new, and alternative structures do exist in corporate governance, which empowers employees at the board level, such as in Germany.
Nevertheless, questions remain, especially over the right level of "incentives" for bosses. Will a boss work so much harder if he earns five million rather than four million a year? Seeing his business peers at an equally valuable company earning more than him, he may feel demotivated and keen to move on in the global market for CEOs.
In this sense, in a globalized mobile world it is hard to control pay for a top executive who can simply leave for a better paid job – hence making the principle of shareholder accountability somewhat defunct.
If shareholders cannot control the excessive pay levels of their executives, then there is a strong argument in favor of State intervention in the private sector – not just on a national level, but on an international level.
To appropriately incentivize and maintain the CEO performance link there is a variety of compensation schemes available in addition to fixed payments, including stock options. They can be considered as better aligning CEO incentives with the company’s long-term success.
The balance must be struck between short-term and long-term interests. Stock options where the bonuses can be paid to the executive up to seven or 10 years after they have left their post is a method of aligning the long-term health of the company with the rewards of the manager – by ensuring that even after the executive leaves the company, the company is in good shape.
Of course, the decisions and strategies top executives decide on carry huge responsibility and can be the difference between making or losing the company millions or even billions of dollars.
What really is the "unacceptable face of capitalism" is when a company performs poorly and the boss receives a huge salary and a bonus. It seems it is not only the "unacceptable face" – but also the dysfunctional face of capitalism.
This is a fundamental difference between public and private companies. Often in private companies the bosses (agents) are also the shareholders (principals). Therefore, they can take as much money out of the business for themselves as they wish as they are also risking their own money if the company performs badly.
This key link is missing in a public company, whereby the bosses have a high fixed salary, plus bonuses without the corresponding risks.
The U.K. is largely understood to be the most shareholder-friendly jurisdiction. However, U.K. shareholders have weak incentives due to their small holdings, rational apathy and liquidity.
Therefore, policy proposals providing long-term shareholders increased rights (voting rights for example), at the expense of short-term holders, is a desirable method of monitoring the short-to-long-term interest of the company and executive remuneration.
Christopher Georgiou is a writer from the U.K. He is currently working in China.
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.
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