High Pay Commission

When an economy is booming, unjustifiable inequalities in pay can easily escape people’s attention. In these straitened times, with swingeing cuts in public services about to hit the most vulnerable, it is time to look more carefully at how work is rewarded in our society. We need to move beyond naïve attitudes about top pay, and to realize that recognizing the significance of incentives should not lead to acceptance of the gross forms of daylight robbery that pass for executive compensation today. A good place to start is by looking at corporate governance.

The facts about income inequality in the UK are nothing less than mind-boggling. The average income of a FTSE 100 chief executive, according to the most recent Guardian survey of executive pay, is over £3 million per year, including bonuses and pension contributions. This is more than one hundred times median household income. It is not uncommon for ratios between the pay of CEOs and the median pay of employees in their organizations to run up past two or three hundred to one or, as in the case of Terry Leahy’s final year at Tesco, for a CEO to be paid five hundred times the take home pay of his average colleagues. (This is not to say that Leahy was not an impressive Chief Executive; after all, Tesco did very well under his leadership. But in many more cases, rewards are completely uncoupled from performance.)

Moreover, executive pay continues to march relentlessly upwards, unconnected to skill, judgement or underlying profitability. While the FTSE lost a third of its value in the year to September 2009, executive pay rose 10% during the same period. According to the Work Foundation, the ratio of average CEO pay to average UK earnings rose from 10:1 in 1980 to 75:1 in 2006 (and has continued to grow since). In short, the gains of economic growth are becoming increasingly concentrated in a small number of hands, while the wages of ordinary people have stagnated.

Should we care about the inequalities associated with ulta-high pay at the top? New Labour’s emblematic answer, famously encapsulated by Peter Mandelson, is that “we should be intensely relaxed about people getting filthy rich”. Looking at runaway top-pay with a clear eye on its social and political consequences, Mandelson’s claim looks as short-sighted as it is wrong-headed.

As against what Mandelson would have had us believe, there are lots of reasons to care about such searing inequalities of income. For one, where marginal gains in top pay do not directly contribute to increased profitability, they are simply inefficient. Ultra-high executive pay is an extra cost of doing business, and siphons away money that might otherwise be redirected to higher profits, or to higher wages for average workers. Moreover, given the diminishing marginal utility of money, the average shareholder or average worker would be much more likely to derive some real value from a share of that extra cash, as opposed to an already wealthy CEO.

Moreover, runaway executive pay undermines relations of social solidarity, and creates a “them and us” society in which one small section live lives that are unrecognizable to their colleagues and co-citizens. In a time when we’re told that “we are all in this together”, the social dislocation and alienation caused by such horrifying disparities in reward become harder to justify. Moreover, it can hardly be good for morale within companies to have a pay structure that communicates to employees the belief that their contribution is negligible, and all the hard work is done by the CEO. Nothing could do more continuously to undermine the self-respect and sense of self-worth of those on low pay than to see their senior managers earn rewards that are orders of magnitude greater than their own rewards.

What other reasons might we have for being worried by ultra-high pay? For one, we may be concerned that the creation of a small, powerful class of ultra-high paid individuals can be dangerous for democratic politics. The concentration of wealth in a few hands means that a few rich donors can have excessive influence on the policies pursued by governments or adopted by opposition parties, as political parties bend over backwards to secure the largesse of wealthy donors. Where savage inequalities in reward get going, patterns of political domination and the undermining of democratic politics soon follow. Moreover, there are real costs for the life-chances of normal young people in our society when the ultra-high paid are able to do so much to smooth the paths of their gilded offspring, undermining the possibility of real equality of opportunity for all. (For a fuller treatment of the various reasons we have to care about large economic inequalities, see T. M. Scanlon, “The Diversity of Objections to Inequality” and Martin O’Neill, “What Should Egalitarians Believe?” and “The Facts of Inequality”, references below.)

One might respond to these worries by saying that the market cannot be bucked, and that executives are only ever paid what they are worth in a competitive environment. But this is very far from the truth. Most executive pay packages aren’t negotiated in a cut-throat marketplace, but are settled by cosy remuneration committees, comprised of other members of the charmed circle of corporate largesse. The same lazy-headed, complacent and overgenerous culture that can lead to monstrous pay settlements in the public sector (like BBC Director General Mark Thompson’s absurd and damaging £800,000 salary) is alive and well in the private sector as well. To assume otherwise is to have a naïve faith in markets, isolated from the reality of their operation, and unsustainable in the face of recent history.

Indeed, it often seems as if the public and private sectors are prepared continually to outbid each other in learning from each other’s bad habits, especially when it comes to generating cosy circles of generosity, unhitched from reality. The more that parts of the public sector seek to model themselves on the perceived standards and procedures of the private sector, the more strikingly absurd pay awards become. Among the most brazen offenders are some Universities: at the University of Liverpool, Howard Newby moved from being a member of the University Council (the body that appoints the Vice-Chancellor) to appointment as V-C, pocketing a wage 20% above that of his predecessor, at a scarcely believable £386,000. When we see unjustified splurging on executive pay in public sector institutions, their integrity and standing is undermined to the point of destabilizing public trust in those institutions. But, given the structural similarities to private sector procedures, we should be just as quick to lose trust in corporations which grossly overpay their managers. For both public and private sector organizations, runaway executive pay is often a symbol of a lack of openness and transparency, and of remuneration procedures that have been ‘captured’ by their beneficiaries, rather than operating with due integrity.

Cosy remuneration committees breed socially corrosive forms of inequality, but they are also expressions of an underlying inequality. It is precisely because of the existence of clubby circles of excessively concentrated economic power that the lax practice of unjustifiably generous executive pay is so deeply entrenched. Rather than looking only at the consequences of these inequalities of power, it would thus make sense to tackle this problem closer to its root.

One way of addressing these gross inequities would be to change the composition of remuneration committees, adding some broader and more critical voices to the mix, and disrupting the complacent back-slapping. Proposals for worker representation on remuneration committees would be a promising way forward. It would inject a dose of realism into the determination of corporate pay, as the presence of even a single dissenting voice could puncture group-think, and lead to pay policies that were broadly justifiable to all sections of an organization, rather than only serving the interests of a self-perpetuating elite. Moreover, such procedures could give trade unions a valuable and constructive role to play in contributing towards the pay policies of the companies in which their members work (bearing in mind that their members will typically have a long-run interest in the success and profitability of their employers).

Moral philosophers have long recognized the special significance of face-to-face justification. John Stuart Mill talked about our deep-seated wish to “be in unity with our fellow creatures”, while Harvard philosopher T. M. Scanlon characterizes the fundamental core of morality as our recognition of the reasons we have to be able to live in such a way that we can justify our actions to others (see his book, What We Owe to Each Other). Both Mill and Scanlon get at something deep-seated here, and it’s true, even of the wealthiest CEO’s, that they want to be able to feel that their pay-packets are justified.

Clear thinking about reforms to ultra-high pay needs to be embedded in a broader set of debates about the reform of corporate governance in the UK. Many proposals may be worth exploring. For example, as things stand, a company AGM votes to accept or reject the annual report as a whole. It would be a straightforward matter to you make the parts of the Annual Report dealing with executive pay severable from the rest, so that shareholders could vote down the executive compensation committee’s proposals (together, but separate from other parts of the annual report). Institutional shareholders such as pension fund managers often hate the fact that such a large proportion of a company’s resources are spent on executive pay, but nevertheless do not have any weapon short of the “nuclear option” of rejecting the annual report, if they want to address this problem. Even the most traditional capitalist, with no time for egalitarian arguments, would surely agree that executive pay should not be able to escalate without reform even when it is directly against the wishes of the people who own the company – that is, the shareholders.

A powerful feature of more broadly based remuneration committees, with worker representation, is that they could build this human need for justification into the determination of corporate pay. Justification could also be brought to the fore, in another way, by making boards more accountable to their shareholders. Rather than enforcing a dogmatic equality of rewards, reformed remuneration committees or democratized AGMs would both have good reason to allow generous pay where it matched an outstanding contribution. But they would also be empowered to call the bluff of second-rate executives who have long got used to being unjustifiably in receipt of stratospheric rewards. It is high time that we addressed ourselves seriously to the question of what the institutional means might be to end the ugly and corrosive plutocratic excesses of self-generated and self-sustaining managerial larceny.

References:

Martin O’Neill, “What Should Egalitarians Believe?” Philosophy & Public Affairs, 36.2 (2008)
Martin O’Neill, “The Facts of Inequality,” Journal of Moral Philosophy, 7.3 (2010)
T. M. Scanlon, What We Owe to Each Other, (Cambridge, MA: Harvard University Press, 1998)
T. M. Scanlon, “The Diversity of Objections to Inequality,” in his The Difficulty of Tolerance, (Cambridge: Cambridge University Press, 2003)

Tags: CEO Pay, Corporate Governance, Inequality, Shareholder Rep

This entry was posted on Tuesday, November 9th, 2010 at 9:43 am and is filed under Addressing, Fairness, Submissions. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.