Cable’s proposals will harm business and politicise pay

Vince Cable’s proposals on executive pay do not really amount to a great deal, but it is worrying that the coalition now seems to have firmly accepted that top pay in the private sector is something in which the government is entitled to intervene.

Mr Cable repeats the Prime Minister’s misleading assertion that rising executive pay is a ‘market failure’, which he seems to attribute to the structure and composition of UK remuneration committees – although the same trend  is evident in other countries, from the United States to China, which have very different ways of determining pay.

Although it may be producing a situation which many people dislike, the UK executive market is not failing. It is reacting rationally to the increasing internationalisation of business (remember that over 70% of FTSE-100 company turnover is generated abroad these days) and to the increasing level of responsibility, stress and high visibility facing chief executives (the public shaming of people like Fred Goodwin reminds potential CEOs of the downside risks of decision-making and adds to the premium needed for those taking key jobs).

Turnover among CEOs is very high – around one in seven each year. This reflects on the one hand the fact that for talented executives there are many highly rewarded alternatives to working in publicly quoted companies, so PLCs need to pay sufficient to compensate. To the extent that high and rising turnover is involuntary, potential CEOs also need to be assured of a favourable exit package. This is in many cases not ‘reward for failure’ but the consequence of changes in the external environment which are in no sense the fault of the executives concerned.

Recent surges of executive pay in the UK surely also reflect the effect of taxing marginal income at 50%: in a similar way leading European footballers are increasingly demanding higher pay to move from low-tax European countries to the Premier League.

What of Mr Cable’s proposed measures? Some are harmless. The requirement to publish a summary figure for remuneration is hardly onerous – although there are ambiguities in valuing share options and so forth which reduce the value of such a figure. Some are pointless and irritating: the last thing we want on remuneration committees or company boards (in the blessed name of ‘diversity’) is a bunch of academics and lawyers rather than businesspeople.

Some, however, could cause some collateral damage. A ‘binding’ vote on pay packages may reduce companies’ flexibility in recruitment, and will divert resources of time and energy towards placating key shareholders. If such a vote goes against the board it could precipitate a major crisis within a firm for reasons which may have little to do with its core business. The general introduction of ‘clawback’ rules to make allegedly failing executives repay their rewards positively invites litigation, for failure is rarely clear-cut. To avoid this, companies may tolerate poor performance longer than they should – surely a perverse result.

The measures are unlikely to do much, though, to reduce executive pay. Shareholders are exhorted to take a more active role in keeping pay down, but why should they? Executive pay is a tiny proportion of company costs, with little direct impact on dividends or share prices – but getting the right executive team in is vitally important for the business. 40% of shareholders are based abroad, and may pay rather little attention to over-excitable UK politicians. Most shares are traded rapidly in response to market fluctuations. Long-term shareholders are as rare as horse-drawn buggies these days.

The danger is that the failure of the Cable package to have much impact will invite further, and potentially more damaging, intervention. The Business Secretary boasts that 10 out of 12 recommendations of the High Pay Commission have been accepted, and he is indeed creating a new, presumably publicly-funded, busybody role for its chair, a former Guardian journalist. But Compass, the leftist backer of the HPC, wants more. So does the Labour Party. One thing it says it wants is publication of a ratio between the CEO’s pay and that of the lowest-paid employee, and David Cameron has expressed sympathy for this. The predictable outcome of such a requirement would be that PR-conscious firms would outsource their low-paid work.

Another suggestion is that employee representatives should be placed on remuneration committees, a recipe for conflict. If some election procedure is involved, this would likely be strongly influenced by unions who would take every opportunity to contrast executive pay with deserving cases lower down the hierarchy and maybe influence paysetting for the firm as a whole. This politicisation of pay would take us back to the days of incomes policy and would lead to inefficiency and higher unemployment.

Mr Cable and his supporters are playing a silly game, the future consequences of which could be serious. The pay proposals are irrelevant to the economic problems which the country faces, and upon which the government should be concentrating.

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.

2 thoughts on “Cable’s proposals will harm business and politicise pay”

  1. Posted 24/01/2012 at 14:26 | Permalink

    I would be interested in seeing work comparing pay in private with pay in public companies. It seems that since previous reforms to increase shareholder power and transparency, the result has been that executive pay has increased. David Cameron keeps banging on about market failure, but less management capture is likely to lead to an executive team that pursues return on equity more vigourously and consequently gets higher pay. The problem is that looking at one variable alone “increases in executive pay” tells us absolutely nothing. It could be rising because shareholders allow their companies to be captured by management to a greater extent than they used to or it could be rising because executives are adding more value in an internationalised market or in a context in which they are actually better held to account by shareholders than they used to be. Having started work in an institutional investors in the mid 1980s, I can say where my hunch lies.

  2. Posted 25/01/2012 at 09:02 | Permalink

    A turnover of one CEO in seven every year doesn’t seem particularly high to me, especially as people are more likely to become CEO later in their career and so a greater proportion leave due to retirement than in the workforce as a whole.

    Len Shackleton also says: “Executive pay is a tiny proportion of company costs, with little direct impact on dividends or share prices – but getting the right executive team in is vitally important for the business.” but says elsewhere “The general introduction of ‘clawback’ rules to make allegedly failing executives repay their rewards positively invites litigation, for failure is rarely clear-cut”

    So, as we know that failure (and success) are rarely clear cut (because so many factors can affect company performance – not just the performance of the CEO, however good or bad) how can anyone be really clear about whether they have the “right” executive team?

    I’ve worked for many companies and just two CEOs were very clearly responsible for the company’s success. In the first case, the CEO founded the company, so no argument there. In the second, there was a large element of good fortune about the company being in the right place at the right time, but it was the CEO that saw the magnitude of the opportunity and exploited it highly effectively. However, in the other cases, although I personally thought some bosses were good and some not good, it would be very difficult to quantify to what extent they were responsible for the success or lack of success of the company concerned – the situation the company was already in was a much greater factor.

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