Hidden costs of the CEO pay bonanza
SOME time ago, a rather learned economist suggested that criticism of executive pay could be attributed to envy. This was another of those blindingly obvious statements that economists get paid so well to make. Perhaps because it is so obvious, it tends to be repeated.
Envy does, of course, play a part in the criticism of executive remuneration. As the single most important driver of the consumerism that underpins modern capitalism, envy should be acknowledged as a powerful motivating force in much of what we do. After all, it is not need that drives the acquisition of untold pointless luxuries, but envy — or, as the marketing people might say, “aspiration”.
It is also envy that forces remuneration consultants to refer to the top quartile of packages for even the most pedestrian of executives.
So of course envy is involved — rather like those of us who have not even bought a lottery ticket being envious of the winners. People are envious because they see exceptionally large sums of money and do not believe they are justified or justifiable. To most people, the awarding of these sums is as random as a lottery win.
But envy is only part of it. And if executives and the economists who advise them believe that envy explains it all, then things are a lot worse than we imagine and the sense of executive entitlement is deeply and dangerously ingrained.
Beyond envy, there is the inefficiency of a reward system based on self-dealing. In no efficient market is the seller of a service allowed to determine the price of that service. That is only allowed when the market is rigged or there is a monopoly.
The intrusion of remuneration committees and remuneration consultants does nothing to change the fact that the process results in companies paying far more for executive talent than would be necessary under efficient market conditions. The committee members rely on the goodwill of the executives to secure their well-remunerated positions on the board, and the consultants rely on the executives for their fees.
One way around this would be for trade unions, which control a large chunk of the JSE through their provident funds, to insist on appointing two or three members to every board. At the very least, that should ensure a more vigorous debate.
In addition to overpaying for executive talent, it is inevitable that the whimsical way in which exec- utives are rewarded acts as a disincentive to all other employees. The generosity of the packages screams out one message: the success of the company is entirely dependent on two or three top executives. There are only a handful of companies across the globe where this might be true.
But perhaps the most important reason for criticising executive remuneration is that it incentivises behaviour that will boost shortterm profit and share price performance without regard for the long-term sustainability of the company. The increasing use of cash to repurchase shares rather than invest in growing the business should be seen in this context.
The most eye-wateringly generous — and therefore the most dangerous — part of a remuneration package is the long-term incentive. Bizarrely, “long-term” is defined as no more than three to five years.
In addition to getting a load of money for just pitching up at the office every day, the executive stands to secure a windfall if he attains certain objectives within a three- to five-year period. These objectives are generally linked to things such as return on equity, return on investment and/or share price performance. As a result of the incentives, executives are running their businesses not for longterm profit growth, but for shortterm return on equity. This often involves harvesting previous investment, buying back shares and paying generous dividends.
This strategy suits institutional investors who are also rewarded on the basis of short-term share price performance. But it certainly doesn’t suit the millions of workers and savers who need companies to invest in long-term growth. Indeed, the strategy represents a major threat to the capitalist system — a far greater one than the so-called unreasonable wage demands of workers.
So there’s a lot more involved than just envy.