Executive Salaries
Admin's note: With the current attention that executive salaries are receiving, not least in the wake of the large layoffs last week at Pacific Brands, we are re-running a post from last November by David Wishart, dealing with this issue.
The best frauds are those that are legal. You cannot get caught for them.
By ‘fraud’ I mean here illegitimate gain or reward, preferably huge. ‘Illegitimate’ means without moral justification. By now you will know what I am talking about. That says a lot in itself. But just to be absolutely clear, this essay is about excessive rewards for corporate officials.
What is said to justify rewards worth millions of dollars? Four justifications are commonly deployed. These are: the reward is deserved, that shareholders have consented to it, it is compensation for risk-taking, and that the market sets the price. Looking at each in turn, as I do below, none is persuasive. Hence I would argue that high rewards for corporate officials are illegitimate and a fraud on society.
Is the reward deserved? Not on any rational calculation. Why should anyone receive a reward of the order of 100 times the average pay of an Australian worker? Corporate executives are not working harder or longer hours than most. Even if they were a multiple of just two or three, perhaps four, might be justified. Twice as hard for twice as long is just about the conceivable maximum.
Do more important jobs deserve more pay? To argue so is fraught: Who judges importance? Is being an official in a company so much more important than the Prime Minister’s job, let alone that of the teacher of one’s children? Many would argue that the entrepreneurial classes are leeches on society rather than productive members.
Moreover, we do not have to rest our case on absolute importance. Average executive pay has being growing at many times the rate at which average pay has been growing. Twenty or thirty years ago it was twenty or so times that of the average worker, yet now it is hundreds of times that of the average worker. There is nothing to suggest that there has been any change in the work done by executives that deserves such differential growth. It may be that there is a little more regulation, yet so it has been for all of society in this era of deregulation and the hollowed-out state
Sometimes it is argued that since the officers have made billions for the shareholders, they deserve millions — a cut, as it were. I would like a cut of the pay of the lawyers I have trained on the same basis. But then I am not fully responsible for their efforts and successes. That can be said of corporate executives too. Any logical connection between reward and benefit conferred is illusory unless it depends of consent or contract, about which more below.
If it is conceded there is no external measure of the value of work, the apologist for high executive salaries often asserts that since directors’ pay is decided by the shareholders and since it is their money which is being given over, no-one has the right to complain. Surely, it is further argued, the best measure of desert is what shareholders think executives are worth. A cheap answer might be that while this is theoretically true for directors, executive pay is set by the Board of Directors and hence the shareholders have not in fact decided the matter. Of course, this is to ignore the issue of consent and that whenever executive remuneration is raised in meetings the vast majority of votes are in favour of the suggested arrangements. There are, however, more sophisticated answers.
Most shareholding is through institutions: superannuation trusts, investment vehicles, insurance companies and the like. Decisions as to voting policies in respect of these are made by the self-same executives who are in receipt of excessive executive salaries. There are no prizes for guessing which way they vote. This process of self-serving decision-making is compounded by the proxy system which allows the trust of people in existing management to be expressed by conferring their vote on them — allowing that trust to be abused. This itself is exaggerated by the degree to which there is systemic propaganda that excessive rewards are either necessary or justified. Many shareholders take the position that, while the remuneration of executives seems outrageous, they are not in a position to know. Given that, when it is spread across all shareholders, the cost of executive salaries impinges little on each shareholder’s receipts, the advertised risk of losing the whole investment due to poor management seems not worth taking. In that perversion of insurance well known to organised crime, executives threaten loss in order to enhance their own wealth. In this situation, consent means little.
Perhaps, then, executives face huge risks for which they have to be compensated. Of course, these risks are purely financial, which, for some reason, seems to be considered to be more compensable than risk to life, limb and health. Moreover these risks can be quantified by comparing them to the insurance cost for those risks. After all, most of those risks are in fact insured against by executives. The only ones that are not are those involving dishonesty, and a potential for dishonesty is hardly a legitimate justification for higher remuneration. The cost of insurance against the personal risk faced by executives does not in the slightest dent their remuneration packages.
To cap it off, just what are the risks that have so increased that remuneration should be multiplied? Liability for insolvent trading was introduced in the early 1990s, but was mitigated by the possibility of external administration. The derivative action was provided to provide a means to enforce more onerous care and diligence requirements, but these were offset by the safe harbour of the business judgment rule. In any case, the degree of care and diligence required is only that of a reasonable person in that office in that kind of firm — not an unreasonable requirement. New civil penalty enforcement measures came into play but only for conduct which always had been thought wrong and in any case the fines are, for a person on millions of dollars a year, trifling. To be sure, they can involve banning orders, but that has to be for conduct of the ilk of that on the HIH or OneTel scenarios, or perhaps for repeatedly bankrupting firms. There has been some extension of liability for corporate wrongs through notions of corporate culture and adoption, yet balanced assessment would reveal that there is nothing about which even a half-competent manager would feel concerned. After all, the common defence is of due diligence.
Defences of the legitimacy of executive pay packages inevitably retreat to the last justification. This is that the quantum is set by the market: to pay less is to risk poor management. Like all arguments based on economic theory this rests on assumption, in this case mostly false, and, in any case, does not legitimise — it merely observes a deep societal flaw about which we should do something.
A market needs buyers and sellers, a well-defined commodity, information about price and the commodity, and a transacting process. Without indulging myself with a demonstration of how accepting just this as a description of how the world works inevitably leads to gross distortion, applying them to theorise a market for executive services reveals serious logical flaws. First, the buyers and sellers are the people in the same sorts of position and they only wear partial responsibility for their actions. There is little incentive to compete down price. Second, the commodity is a long term service the performance of which is not measurable hence is not definable. Third, the more incentive payments are put into play to indirectly measure performance, the less we know about price.
The fourth flaw in the market justification of excessive executive salaries is less obvious, but perhaps the most cogent. It is that, as a justification for incentive payments and as a response to a general mentality in society, managing as the service about which market transacting takes place is cast in a frame of risk-taking. The explicit formulation that ‘risk’ in this sense is not that which is insurable, but is uncertainty with which some persons are better endowed to deal. Just as we pay hugely for naturally skilled players of sport, so we should pay for naturally skilled players of uncertainty, runs the argument. Yet, by definition of uncertainty, there is no way to determine if a particular person has benefited from uncertainty by chance or by design. In other words, what executives do, when their activities are cast in the mould of uncertainty, is inherently unknowable.
The genetic construction of competence apparently accepted by the business community in the case of the Murdoch and Packer families exemplify the last point. What other sphere of society blindly allows a system whereby high status is accorded simply by virtue of parentage? To parentage we can add in other cases the qualities of a pleasing demeanour and sheer luck. In the face of uncertain job criteria the most extraordinary set of characteristics seem to be deployed to indicate desirable traits.
The precise functions of a chief executive officer of a large firm are seldom articulated. When we choose between people in such situations it is well known that we choose ourselves, hence management becomes, in the well known phrase, a self-perpetuating oligarchy. Supply is thus constrained and price goes up. Of course, if uncertainty is taken out of the frame, the functions of executives are knowable, people are trainable and supply will rapidly increase.
If, under examination, none of these justifications hold water, what can be done about the fraud on society represented by excessive executive salaries? Given the power structures in place and the workings of the corporate system, apparently very little. Yet those power structures are maintained by ignorance and belief. We simply accept the notions put forward to legitimise the taking of so much wealth. As a first step to encouraging critical thought we should place a much tougher burden of legitimatisation on the executives themselves. We can do this by regarding the accumulation of such wealth as abhorrent in itself. It is a fraud unless it can be positively demonstrated otherwise. Then we can and should subject the arguments to rigorous critical examination.
