Tuesday, 10 June 2008

Oh no...

I know the arguments about not scaring the horses, I know it is important to not spook the City, I know we have to approach executive pay carefully. But this is terrible (from FT article here):

"We will resist the calls that have been made for direct regulation of executive pay," Ms Ussher will say in her speech. "Of course, remuneration packages should be strongly linked to effective performance, and incentives should be aligned with the long-term interests of the business and shareholders, and we don't support rewards for failure."

But she adds: "I'm clear that executive pay is a matter for boards and shareholders, not for governments and regulators."

Aside from the obvious point that the only reason that shareholders even have a vote on pay is because of Government intervention, I think this is a disastrous thing to say. It makes the enormous assumption that 'shareholders' have the incentive and resource to make sure that management acts with restraint when setting pay. So behold my regularly repeated arguments for why this is wrong.

First, there's an argument articulated by Tim Harford in his recent book that even if self-motivated shareholders are thinking rationally they won't consider high pay to be too much of a problem (because to each shareholder the 'cost' of inflated pay is small). But we aren't even in that ideal world because the principal-agent problem is present not only in the company-shareholder relationship, but also in the fund manager-pension fund or insurance company-policyholder relationship. Given that fund managers are paid to generate returns, not police pay, why do it to any serious extent?

And what about the conflicts and biases at play on the part of fund managers? Why get stroppy with a company whose pension fund might be tendering a mandate? What about fund managers that are also part of listed companies themselves? How much restraint is there in their own pay packages. And the fund management world isn't too shabby on the pay front either. Is asking people who are well paid themselves to judge the pay of others a smart idea?

Instead of simply trying to kill off this debate, why doesn't the Government simply review how the vote on pay has worked in practice. They can still kick the findings into the long grass if need be, but at least we could have a proper debate about whether 'shareholders' can deal with executive pay effectively.

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