Saturday, 13 September 2014

Different interests in executive pay

There was a sorta, kinda interesting piece about executive pay in City AM the other day. Interesting in that it clarifies where mainstream corp gov thinking has got to, and that, in my view, it demonstrates some of the continuing confusion and/or obfuscation embedded in it.

Essentially the argument is that a really basic approach to executive pay (Level 1) is to try and fix it (as in a fixed ratio), cap it or tax it. A slightly more sophisticated approach (Level 2), it is argued, is to muck about with incentives. But what really sophisticated pay reformers (Level 3) should be looking at is long-term delivery of awards. So the big idea proposed is longer term vesting of awards.

As the article says: "Level 3 thinking thus focuses on the structure of pay."

As I say, I think this is actually where the corp gov mainstream is at - for example, it's basically the line that Fidelity has been pursuing. The focus on "career shares" is in a similar place. The core assumptions are: the most important issue is structure not scale, performance-related reward is an inherently good thing and long-term awards incentivise long-term performance.

So far, so obvious. And I disagree with all of it.

The thing I particularly want to focus on is the idea that reforming things like vesting is more sophisticated, and that other ideas (examples given in the article include fixed pay ratios and higher taxes) miss the 'real' issues in executive pay. The intro of the article makes this sort of argument -
EXECUTIVE pay is a high-profile topic which almost everyone has an opinion about, and many believe the entire system is broken. But despite being well-intentioned, many suggested reforms may not be targeting the elements of pay that are most critical for shareholder value and society.
Much of the debate is on what I call a Level 1 issue – the level of pay. The European Commission is contemplating a binding vote on the ratio of chief executive pay to median employee pay; proposals to raise taxes – most prominently made by Thomas Piketty – are a response to seemingly excessive pay levels.
While both measures address income inequality, it’s unclear that they would do much to improve firm value. Levels of chief executive pay, while very high compared to median employee pay, are very small compared to firm value. For example, pay of £5m is only 0.05 per cent of a £10bn firm. That’s not to say it’s not important – a firm can’t be blasé about £5m – but that other dimensions may be more important.
In response, I think this fundamentally misunderstands what the debate around executive pay actually involves. The simple reality is that different groups want different things and, in my opinion, it's hard to achieve all of them. It may be that - within the area of executive pay policy - there aren't proposals that reduce inequality AND increase firm value, or at least that have much impact on both. We may have to choose between them, or choose where we want to put most emphasis. It may well be true that wealth taxes, pay ratios and the like won't increase firm value (there may be better ways to achieve the same ends too, but that's another issue). But equally in the proposals that are put forward by the corporate governance mainstream I see nothing that will reduce income inequality, or even seeks to. I think it would take some work to claim that long-term vesting is going to have an impact on it, for example.

Therefore to assert, as many continue to do, that the 'real question' in executive pay is structure, not scale, is not sophistication, it's a failure or refusal to listen to and acknowledge other voices. If I have a particular concern about income inequality then it's simply false to claim the 'real issue' in executive pay is structure (or, in the article above, to claim that other dimensions than scale matter more). Not to me it isn't.

In fact, in essence, aren't those those who argue that the 'real issue' in executive pay is structure simply asserting the interests of one set of stakeholders - shareholders, but in reality principally asset managers - over others? If other stakeholders have a different view - like that the pay gap is more important than performance linkage - this does not necessarily mean that they are missing the big picture, they simply have different priorities. So to argue that the thing to focus on is structure boils down to saying that the interests of those who want such a focus should win out.

As I've blogged before, much of the corp gov/RI community is obsessive about 'win win' outcomes - what might also be called painless reforms. There is also a tendency to see dissent and disagreement as something to be avoided if at all possible. Well, one area where you can get a bit of consensus - at least between big business and big finance - is that we should be focusing on reforming the structure of pay, and less on absolute levels. By mainstream corporate governance standards, because both the CBI and asset managers can reach agreement in this territory, it is self-evident that this is where sophisticated reforms lie. (I also share Roger Bootle's view that saying focus on structure is a smart way to change the conversation, and shift it away from scale.)

It's more likely, in my view, that where it's easy to find a consensus on executive pay that's because not much is being challenged. The CBI, for example, are quite happy to bang on about 'rewards for failure' because in the narrow sense they mean it (big pay-offs to departing directors of failed/failing businesses) there aren't that many cases and you'd have to be a real corporate shill to defend them. However, go even slightly further down the same track - clawback - and you find much less support. I think the reason it is possible to reach consensus on 'sophisticated' reforms to exec pay like greater performance linkage and long-term vesting is because everyone knows the fundamentals don't really get touched. If anything I'd expect exec pay to rise a bit to offset the fact that recipients will further discount awards that are now even further in the future.

The consensus is possible because the corp gov mainstream is only trying to iron things out between directors and asset managers. Hence issues about pay disparity within firms, and rising inequality don't get a look in. If they did, consensus would be a lot harder to achieve, if at all.

Many people in corp gov dislike these issues 'becoming politicised' (as if they were not inherently political issues), usually meaning it's a bad thing that politicians and policymakers are getting interested and/or drawn in. But at least politicians are used to dealing with conflicting interests and trying to reach a compromise between them. They are used to situations in which for one objective to be achieved, or one interest to be served, another is thwarted. Sometimes everyone is left unhappy, and you just have to settle on the least worst set out outcomes. But at least compromise isn't bought at the price of simply deciding asserting the primacy of one set of interests. The sophisticated consensus envisaged in Level 3 thinking is only achievable because so much else is left off the table, and other interests ignored.

To return to the idea of levels of thinking about executive, to me Level 1 thinking is demonstrated by the argument that the structure of executive incentives should be the limit of corporate governance policy. To me greater sophistication, Level 2 and up if you like, involves acknowledging that different stakeholder interests in this debate do not always overlap, and therefore we may need to make trade-offs, perhaps significant ones. This should be the start of the discussion, not something that we try and gloss over for the sake of a sterile consensus.

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