Reassuringly bad arguments

I haven't blogged about the High Pay Centre for quite a while. They have successfully managed to establish themselves as a sort of mirror of the Taxavoiders Alliance, with the same kind of well-evidenced but populist campaigning stance. Which is great because it gets right up the noses of TPA supporters.

But I thought it was worth giving them a plug as the reactions to their latest work on Fat Cat Tuesday give a real insight into the strengths/weaknesses of certain arguments. More specifically, I think the counter arguments that are coming from organisations like the Adam Smith Institute are reassuringly bad. It suggests that they either just don't understand the turf as well as the HPC, or they are really struggling to overturn what the HPC is managing to define as "common sense" about executive pay. Either way it's a good sign.

I won't tackle the whole of the ASI's response, as Paul Marsland at the HPC has done a good job of that here. I just want to focus on the question of shareholder involvement - the argument that we should leave executive pay up to shareholders, because it's "shareholders' money".

I think this is wrong-headed on several levels. First, let's be clear on the process here - "shareholders' money", as it relates to distributions from a specific listed company, is only "shareholders' money" when companies decide it is, for example when they pay it out to them in dividends. And this is after wages costs etc have been covered. The company decides the distribution, and by definition what it parcelled out to executives and shareholders respectively is their money. At no point are wages for FTSE100 companies, for execs or shop workers or whoever, "shareholders' money". They are separate and one does not have claim on the other. Shareholders can, and do, challenge the distribution, but not on the basis of legal ownership. Essentially they are arguing for their share in the same way unions do.

That is important because, of course, what is being suggested here is that shareholders DO have an ownership claim on the company's assets, so the money that the company gives to its executives belongs to shareholders beforehand. But this is well-trodden ground and the legal reality is that shareholders own shares, which give them some rights, but they don't own the issuer of those shares or its assets. This point has been demonstrated in practice when shareholders have received limited compensation when the government has bought them out. They are compensated for the value of their investment, not for a claim on the assets of the organisation.

Public companies are separate legal entities, limited liability means shareholders aren't exposed for anything other than the value of their investment, but it also means that they don't legally own the company. They are only a residual claimant when a company is wound up. You don't have to be a raging Lefty to believe this, I think it was Eugene Fama who attacked the idea that shareholders own companies in an early paper on agency theory (I will dig out the reference to this).

Even the prioritisation of the creation of shareholder value as a corporate objective is not hard-written into company law (though the UK Companies Act comes close, and companies often act as if it is and genuflect to it to defend controversial decisions).

In practical terms shareholders might be adding to executive pay inflation because they generally do not consider the impact on the market as a whole. So they may be making a series of individual decisions that are seemingly rational, but which add up to higher costs overall. With large investors that hold the market, they might be essentially bidding against themselves for executive "talent". Don't take my word for it, here's what Blackrock said a few years back:

One of the difficulties we face as investors is that we (rightly) assess a company’s arguments for pay changes or increases in light of that company’s circumstances. Generally, companies do present strong arguments for the changes they wish to make. But our assessment tends not to take into account the impact it will have on the trend overall.  

Finally, as Paul, me and many others have blogged at length, it isn't even the case that the "shareholders" are deciding on executive pay. In reality it is almost always the intermediary making these decisions, not the asset owner, let alone the underlying beneficiary. That intermediation brings it's own conflicts, biases (asset managers are well paid) etc. Politically this provides critics of the system with great campaigning lines - the Right wants hedge funds to decide how much corporate executives should be paid, what's the worst that could happen etc.

The reality is that in the modern public company there is no fundamental reason why shareholders should be given a privileged role in the determination of executive pay. It isn't their money, they might not be good at it, and most often the "shareholders" are highly-paid intermediaries.

These days there's a decent amount of people on the Left who do understand quite a bit about the operation of capital markets, who the players are, how their decisions are made, and how this interacts with corporate law and company objectives. So the proposition that we leave executive pay to the market because it's "shareholders' money" is easy meat. In fact it feels like it's about 10 years out of date. If this is really the best that those on the Right who wish to defend current levels of executive pay, and how it is overseen, can do then I am optimistic that we are winning this fight.