Mythbusters: “Huge executive salaries are vital to UK competitiveness”

July 18, 2013 // By: Stephen Reid

The myth

“If we want our economy to be able to compete in the world, we need big businesses to succeed. And if we want big businesses to succeed we need the best people in the world leading them. If the best people can be paid more elsewhere, why would they stay here? You pay for quality, and if that means big salaries and bonuses for the best company executives, that is a price worth paying for the benefit it brings to the rest of us.”

In the wild

“Some people are worth £2 million because they've added masses of jobs, masses of investment, masses of growth… it's the excessive growth in payment unrelated to success that's frankly ripping off the shareholder and the customer and is crony capitalism and is wrong.”

- David Cameron, January 2012

“In a global marketplace, UK-based firms need to pay a competitive rate in order to retain internationally mobile staff – or equally crucially attract new, talented individuals.”

- Mark Boleat, Policy Chairman, City of London Corporation, January 2012

The reality

The global marketplace for executives does not exist

The supposed risk of driving talented executives overseas is perhaps the most commonly cited reason to do nothing about the massive increase in executive pay. This argument does not stand up to scrutiny. Firstly, it is generally accepted that UK executives receive higher pay that their counterparts in most other countries. A study for Cornell University in 2011 comparing companies with €1 billion in revenue found that UK CEOs were the second-highest paid out of 10 advanced economies, behind only the United States, as Figure 1 shows. So UK executives already receive very generous levels of pay, and any reduction would only bring their levels closer to what their international equivalents earn.

Secondly, even if this were not the case, research from the High Pay Centre shows that most major corporations prefer to promote from within, rather than recruiting internationally. Figure 2 illustrates that of the ‘Fortune 500’ list of the world’s biggest companies, only 4 out of 489 CEOs were ‘poached’ while CEO of another company in a foreign country. Over 80% of CEOs at these companies were internal promotions.

Executives are not uniquely talented, nor are they irreplaceable

One of the most patronising aspects of the ‘global market’ myth is the implication that superstar executives are the only people capable of doing their jobs, and that our leading companies would fall apart without them. It gives legitimacy to pay demands of company executives that would otherwise seem outrageous. But it is based on very little evidence. Research from the University of Delaware drawing together numerous academic studies comparing the performance of CEOs promoted internally versus those recruited from competitors shows that those they hired internally performed significantly better than the external recruits. The findings suggest that it is not innate leadership qualities that make for a successful CEO, but a good understanding of the company, its culture and its strength and weaknesses.

Furthermore, it is a very narrow, subjective view of businesses to suggest that they are shaped solely by the skills and wisdom of a handful of executives, directing success from the top down. More innovative pay structures recognise this. The John Lewis Partnership, where bonuses are distributed across all staff, is frequently heralded as a model UK company. At US tech companies, where CEOs such as Steve Jobs or Facebook’s Mark Zuckerberg are amongst the most famous in the world, the practice of share awards across all company employees is commonplace.

Large bonuses and performance incentives at best have no effect on executive performances, and at worst actively harm companies

The theory that executive compensation needs to be connected to company performance, in the form of performance-related pay packages worth many times base salary, is a key factor in the recent increase in executive pay awards. The increase in performance-related pay is meant to incentivise executives, so levels of executive pay should depend on company performance (nearly always measured in terms of profits, dividends and share price movements), in order to encourage executives to achieve the best possible results for the company. However Figure 3 shows how the value of the FTSE100 Index fell in most years over the past decade, while executive pay increased consistently over the same period. Performance has dipped, while performance-related pay has rocketed.

This suggests bonuses do not boost performance. But worse still, there is substantial evidence that they are actively damaging companies. The Salz report into the corporate culture at Barclays concluded that high pay was a key factor in the LIBOR manipulation scandal that cost the Bank nearly £300 million in fines and £4.6 billion in lost share price value. The large sums of money awarded to Barclays staff caused bankers to think they were “above ordinary rules… losing all sense of proportion and humility.” These individuals pursued their personal short-term financial targets, with no regard for ethical or regulatory constraints, at the expense of the Bank’s wider reputation in the eyes of customers and the general public.

Executive pay has damaging effects on society

Decisions on executive pay have repercussions for people beyond the executives themselves and their company. As the Church of England investment committee has observed, executive pay has become so excessive it is a risk to a harmonious society . In more unequal countries, such as the US and the UK there are higher levels of mental health problems, obesity, drug abuse, violence and teenage pregnancy, and lower levels of trust and social mobility, compared to more equal societies, like Norway or Germany. Bristol University Academic Stewart Lansley also notes that the increasing concentration of wealth amongst a tiny super-rich elite is economically destructive. The super-rich are unable to spend the entirety of their income in the productive economy (i.e. consumer goods and services that create jobs) instead concentrating it in non-productive investments (for example, property or shares). By contrast, an increase in incomes for low to middle income earners is likely to result in an increase in consumption, with attendant benefits in terms of employment and growth.

In summary

The UK already has some of the highest paid executives in the world, and so reducing their pay would only put them on the level of some of their counterparts around the world. But regardless of this very few corporations recruit internationally anyway, most preferring to promote internally. It is not superstar executives that lead to success, but those with a good understanding of their business, supported by the many layers below them. Forward thinking companies understand this and distribute rewards to their employees on a much more equal basis.

Many companies continue to argue the need for performance-related pay to incentivise their executives, despite the fact that performance-related pay continues to rise even if the performance of the business dips. There is even evidence that these types of perverse incentives led to scandals like LIBOR.

Finally, executive pay is not just about business, but also affects the rest of society. Huge inequalities, exacerbated by executive pay rates, lead to all sorts of social problems, whilst the super-rich tend to spend excess cash on non-productive investments that fail to benefit the wider economy.

Download the full Mythbuster article by Luke Hildyard (PDF)

Issues

Work & Time, Macroeconomics, Democracy & Participation

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