Tuesday, 31 May 2011

Is Top Executive Pay out of Control?

In the early 1990’s there was lots of talk in the media about the fact that many of the Chief Executives of the top British companies were badly paid when compared to their American counterparts. The argument went that companies could not attract good talent because they did not pay enough. Since then things have changed radically, and it is clear to see that top executive pay is now completely out of control.

The High Pay Commission was set up by the Coalition Government in November to look at pay in the private sector, and has just published its interim report.

It is worth reminding ourselves of some basic principles here. We are talking about the private sector, not the public i.e. government sector. The private sector is divided in two parts, private companies where the ownership is controlled by private individuals, and the public companies, where the ownership is open to the general public.

With regard to privately held companies, what the top management pays themselves should not be the concern of anybody else as long as the management respects the law, and no fraud Is involved. After all, these are companies that have been built up by entrepreneurs or their families who have put their own money behind their companies and taken the risks necessary to succeed. They understand better than most the dynamics to make their companies work effectively. They know that if they pay their employees too little, they could lose them. Most do look after their employees and try to create a family type atmosphere.

With regard to public companies, the situation is completely different. The top management have rarely had anything to do with the establishment and growth of the companies up to the time of their appointment. There are one or two exceptions to this, of course, one of the most exceptional being Sir Martin Sorrell, who was instrumental in the development of WPP.

There is no doubt that CEO’s should be’ well paid’ for the job that they do. It is a question of what one considers to be ’well paid’. The High Pay Commission points to the fact that the average worker is paid £25,816 and a top executive receives £3.75 million, 145 times more than his worker. This is up from 69 times more in 1999. There is no doubt that this appears excessive.

It would not be so bad if this top management were ‘worth’ the salary and bonuses they are paid. The reality is that very rarely are they actually worth it. There are some good examples of top managers who were worth it-Sir Terry Leahy of Tesco-comes to mind, but he was exceptional. Too often they are very well remunerated for failure to deliver the targets set for them.

The average tenure of a FTSE Chief Executive has fallen to 4.6 years as of 2005. The reality is that they have relatively little time in the job to actually achieve anything. Five years should be minimum term, with the object of increasing this to ten years, should results be good in the first five. Knowing this, many Chief Executives probably turn their attention to focusing on how much they can earn in as little time as possible, before the inevitable happens, and they move on.

Warren Buffet, the legendary investor, recently spoke about an interesting concept that a Chief Executive should bear the personal responsibility if a company goes into liquidation under his watch. This would mean his personal bankruptcy, thus ensuring that he did not benefit personally from his own bad management. It would also create a stronger ‘duty of care’ to the company and the employees. There have, after all, been a number of cases of ‘commercial dictatorships’ where the leaders of several companies including Enron, Lehmann Brothers, and Royal Bank of Scotland have led their companies to ruin, but benefitted substantially financially in the process.

The Coalition Government is talking about putting into law the Military Covenant, the country’s agreement with our armed services. It is now time for a new Commercial Covenant. We have just had the biggest shock to the capitalist system for 50 years. It is certainly time to reflect on what changes may be required, and some ground rules set, so that everybody in a company can benefit from progressive capitalism, not just the greedy and privileged few.

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