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Excessive Executive Pay Destroys Value

One of the most concerning aspects of the response to the 2008 banking crisis has been the absence of intelligent debate around the subject of executive bonuses. Calls for government to intervene are an emotional, irrational response. They certainly indicate how high feelings run on the subject. And they are understandable if you or your relatives or your friends have lost jobs as a result. That, however, only makes them rational. It does not necessarily make them reasonable. There are two reasons why governments should not get involved in the debate about bonuses.

* The crisis was caused by issues that are much more complex than just the bonuses earnings of top executives - no matter how unjust such rewards are in light of the scale of corporate failure.
* It is not government responsibility to intervene in corporate administration and to do so at such a microeconomic level would set a very dangerous precedent.

Indeed government intervention to rescue banks is already unprecedented and seen as a step too far by many. Not only does it blur the traditional lines between public and private sectors but it removes the consequences of failure and thus reduces the incentive to avoid future risk.

That they did cross that line may have made governments more reluctant to go even further and take action against executive bonuses. Unfortunately, whatever the rights or wrongs of government action, one of the consequences has been to further politicise the debate. As a result the issue has become an ideological one, where any questioning of the high levels of executive bonuses becomes an attack on Capitalism and all that it has achieved. This makes it a case of protecting the system, rather than looking at the issue as a matter of principle. So the dividing line has become partisan and the debate one of ideological point-scoring.

Yet true Capitalism demands deeper, rational discussion of the subject. The whole Capitalist ideology relies on “the invisible hand” described by Adam Smith. This force steers the market toward equilibrium through the drive to optimum efficiency impelled by the competing self-interest of the different parties. In the lead-up to the crisis various factors combined to remove these counter-balancing effects and make this “invisible hand” more of a “non-existent hand” and emasculate its effect.

There is no question that executive pay was a contributory factor in this shameful debacle. Henry Mintzberg makes the case extremely eloquently in a Wall Street Journal article dated 30th November, 2008. Any executive who is serious about building a successful company and reducing the risk of such a situation ever being repeated should make a point of accessing and reading it. Mintzberg makes a number of good points but a key one that resonated most with me is his challenge of the conventional wisdom that the executive suite is primarily responsible for corporate performance.

No matter how a business is organised its performance is a collective effort. It is the ultimate team game. Consequently it makes no earthly sense for some to be paid (many) thousands of times what the lowest paid employee in their organisation gets. There is no moral justification for it, for no one person can make that much difference to the organisation. Do you remember the space shuttle that blew up because of a faulty “‘O’ Ring”? That design shortcoming had the potential to destroy NASA and, possibly, the whole American space programme. Yet what was the pay differential between that designer and the NASA executive? This is a scenario that routinely plays out in organisations across the country and the world. It is certainly true of the failed banks.

Success is never, ever entirely the result of an individual’s own efforts. This is particularly true in business. So, why should there be such vast differences in remuneration? This pay differential is a moral issue that should be left to the company to sort out for itself. If any government intervention is necessary it need to be no more than to legislate a maximum differential in total remuneration between the lowest paid and the highest paid in the organisation and to make any violation of that a criminal offence. Punishment should include a ban from ever securing an executive position in any organisation. Yet even that would be unnecessary if all employees could be made co-owners of the business and all incentives removed other than a distribution of profits, according to their proportionate ownership. Such a scheme would:

* Enable the company to set its own pay differentials and work within them;
* Provide a transparent, non-subjective mechanism that could not be manipulated;
* Embed organisational teamwork and strategic alignment
* Ensure the long-term focus that has been totally lost in recent years, and reduce the risk of the kind of failures recently witnessed through short-term focus.

Most importantly of all, however, it would provide an answer to a problem that Mintzberg did not identify. A problem that is becoming such a concern that the British Government even commissioned a report on it: employee engagement. No employee engagement initiative will work with the kinds of pay differentials that currently prevail. Such pay differences perpetuate employee disengagement and will sabotage any effort to redress it. Even more significantly, though, they effectively guarantee low productivity and below par performance which the executive team is being paid their huge remuneration to improve! How’s that for irony?

Employee ownership naturally drives the highest possible level of employee engagement. That is why employee owned companies outperform their competitors and the market. And that is despite the limitations of the two existing models of ownership. So imagine what effect a new model that overcame these shortcomings could have on your business. It would almost be enough to make it worth your while to reconsider your executive remuneration practices, wouldn’t it? If only such a model existed. The good news is, “It does!”

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