I left this comment over on Tim Worstall’s blog yesterday, and I thought I might reproduce it here:
“While it is undoubtedly true that there are barriers to entry in certain fields that give the incumbent management the kind of “rent-seeking” powers you talk about, it strikes me that shareholders, over the long run, are hardly likely to tolerate payouts of massive salaries for crummy investment returns. Ironically, it is precisely the sort of mercantilist policies that the left supports – such as attempts to restrict foreign takeovers of “national champions” – that shield management from competition and hence, breed complacency.”
“There is a genuine, global market for talent, and in this globalised, increasingly fiercely competitive world, the pay for the top people will be high. Sure, we can and should remove barriers to entry, and one obvious way to do that would be to encourage small businesses to grow fast and challenge the supposed hegemony of Big Business; this means more free trade, not less; it means fewer regulations and lower, flatter taxes, not more of them, and so on.”
“In other words, if high pay for supposedly underperforming CEOs riles you, then we need more capitalism, not the sort of statist ideas propogated by the likes of Compass.”
For those who may not know, Compass is a leftist pressure group in the UK that tends to argue for such clever ideas as higher taxes, ever greater regulation of business, and so on.
Replied on Chris’s thread, but thought I’d cross-post to here:
“it strikes me that shareholders, over the long run, are hardly likely to tolerate payouts of massive salaries for crummy investment return”
That looks to me like support for the rent-seeking suggestion.
I mean, don’t places with more patient capital, like Japan and Germany, actually have much lower levels of executive pay – and much, much lower ratios of executive/average worker pay – than in the UK and the US, where capital tends to be a little more flighty?
And if shareholders taking the long-term view are the best way to determine a realistic level of executive pay, then shouldn’t we expect places with more of those sorts of shareholders to have more realistic rates of pay for CEOs?
So what needs explaining is why UK and US CEOs are paid so much more than their counterparts with long-term share-holders.
Doesn’t actually prove that there’s rent-seeking going on, but it doesn’t exactly make the idea look silly.
Tim’s thread, obviously. I’m guessing he wouldn’t be thrilled to be confused with Chris Dillow.
CEOs and management in general are “overpaid”. There are some good ones to be sure but many are simply prime examples of survivor principle and have little talent beyond the ability to not screw things up totally.
With that said, there’s really not much point about complaining about them being overpaid. So are rock-stars, footballers and several other professions. Compared to the money that’s flowing, it’s really a small chunk of change and just the nature of the beast.
The ‘overpaid’ issue is, naturally, addressable by asking the question ‘in comparison to what’?
The correct answer should be “When compared to the value they add to the organization they run, as determined by the shareholders”.
The problem is, of course, that shareholders as the only people with skin in the game, are as unqualified to determine what the ‘fair’ level of salary is, as the government, non-shareholders, Polly Toynbee or the ghost of Gordon Brown’s legacy.
But really if you’e directly exposed to the stock market, or indirectly, via a pension plan administered by OTHER people who may or may not deserve these ‘excessive’ salaries, you usually have some means by which you can become activist in the arena.
Yeah, I know it’s *easier* from a US perspective to become a shareholder activist, but the problem *is* shareholders and their willingness to tolerate levels of compensation that they think is ‘obscene’.
It’s easy to forget that share price of a stock is as much a judgment of the value that a management team brings to the table as it is of the value of assets held and income. Consider what the share price of GE might be if Gordon Brown was made CEO tomorrow for a salary and benefits package that’s a fraction of Jeff Immelt’s.
As a shareholder, I want to see the value of my investment rise. The purpose of the company is to maximize shareholder value. So our interests thus far are aligned. Jeff’s high compensation is more than justified for the fact that GE’s share price under his aegis is $16.33 (overpriced IMHO, but still). How much would you pay for a share of GE run by Gordon Brown? Or Paris Hilton? Or Wayne Rooney?
If ‘the market’ values my shares higher (for the immediate and short term future) because the company decides to change its management team and fill the board of directors with a squad of Wayne Rooney’s illegitimate offspring, with a paypacket of $10,000,000 a month I might oppose it because I wanted to invest in the firm for the long run, but I can’t fault the benefit to me of pissing all that money away on ‘executive compensation’ if the share price pops up to $40 a share.
My beef with this is that the firm’s long-term strategy for success is no longer aligned with my perception of the firm’s future.
At which point I (a) cease being a shareholder and (b) therefore, cease having any reason to complain.
There is no valid ‘social justice’ dimension to this. It’s just good old fashioned greed and envy. There are winners, and there are losers.
Oh, btw, I chose Immelt as the example because he has demonstrated excellent expertise in exploiting the US government’s willingness to pick winners and losers. If there is a claim against Immelt (and by extension GE), it’s that he’s being incentivized to exploit the American taxpayer, but I see such behavior as being more the fault of government for interfering than the enterprise for hoovering up the money.
I would be the last one to argue for greater govnernmental intrusion into corporate governance (including regulating executives’ compensation), but to give the devil his due the recent history of shareholders’ supposed “intolerance” of excessive pay is, shall we say, less than compelling. With smaller companies the point is probably accurate. But with huge multinational corporations shareholder “control” is more theory than reality. In-bred, interlocking captive boards of directors rubber-stamp each others’ compensation packages, and actual performance rarely seems to enter much into the discussion. Executives regularly receive huge bonuses even though in reality they may have had little to do with the financial results, but were merely the beneficiaries of fortuitous circumstances (as if oil company executives receiving huge bonuses were responsible for the spike in world oil prices that inflated the value of their inventory and thus their profits).
I suspect that the root of the problem lies with the growth of the institutional investor class (retirement funds, mutual funds, insurance company investments, etc.). Individual shareholders, who would be expected to keep a close eye on the performance of “their” managers, are now a relatively small segment of the investment community. Their voice is muted. Conversely, institutional investors, who now provide the vast majority of capital investment, if they don’t have a political agenda (union pension funds, certain other funds like CalPers, etc.) seem primarily interested in steady, predictable results; their managers all tend to “follow the herd” and have no incentive to challenge management as long as all is going reasonably well.
I don’t pretend to offer a solution to this conundrum, other to say that (1) increased political meddling is surely not the answer, and (2) this is an issue which should be of some concern to those of us who are generally supportive of free markets and the (broad) capitalist system. It shouldn’t be ignored or wished away, if only because it resonates with the general public and thus provides a weapon for our opponents.
I would say we need ethical capitalism. At the moment a lot of CEO performance bonuses take no account of inflation, so ‘sales’ may have gone up by 4%, but inflation has gone up by 5%, so in reality sales have fallen, but a massive bonus has been triggered.
In addition we also have the problem of anarcho-capitalism. BP and Haliburton are good examples, get the oil out of the ground ignoring all potential problems and we know what happened there.
Given the fraud that is gradually coming to light in banking and so on, support for capitalism will fall if the ethics are not addressed. Why let others benefit from a rigged game?
Please tell me you are joking. BP and Haliburton, with their army of lobbyists and lawyers the size of third world armies…and resulting legal privileges those companies secure, are examples of… ANARCHO-capitalism? Or indeed genuine capitalism at all? Really?
Face it, “ethical” capitalism is a code word for “regulatory statism”.
Laird, however I would argue that the same companies that become like that start to become lethargic and their performance wanes. Look at Microsoft for a prime example. Their share price has been stagnant for years. Then look at their technology. Windows Mobile has lost hugely to the iPhone and now Android. Windows is ceding market share to Mac OS, several years after Mac OS was effectively dead. The list goes on.
So in that sense, I think the system continues to work. Small innovative companies can usually run circles around the large complacent behemoths. The biggest problem with that equation at the moment is the amount of government protection in the form of excessive and intrusive regulations that the large corporations can buy to make life miserable for the small guys.
Until relatively recently, German businesses tended to be far more reliant on debt rather than equity financing, so shareholder power over German firms was pretty muted. Sure, some German firms are very well run, but then again, that country’s economy, with its high unemployment, has its own serious shortcomings.
Well, I think some people might wonder whether the economic performances of Germany and Japan during much of the 90s and Noughties really bears out whether their economies have done better than the more “short-termist” onces of the US and UK, notwithstanding the recent problems.
As for some other points, I think it may be true that large institutional shareholders may be less harsh on CEO pay; it is not entirely clear to me how we can sort that out; maybe it might help if shareholders and all savings accounts were made tax-free to encourage a genuine return to a broader form of equity ownership.
Another issue is corporate welfare, which tends to play to the interests of big firms and their management.
Channel Four has just aired the most brilliant and simple piece of economic reality I have ever seen on television.
It is called The Three Trillion Pound Horror Story.
I am amazed this has made it into MSM.
The comments on the website are mainly the usual statist hate stories.
Perhaps help give this programme a plug?
My comment (here) is almost on topic? – CEOs and pay?
The message of the programme is get the “clinically obese” state sector off the back off the back of the private sector.
Until relatively recently, German businesses tended to be far more reliant on debt rather than equity financing, so shareholder power over German firms was pretty muted. Sure, some German firms are very well run, but then again, that country’s economy, with its high unemployment, has its own serious shortcomings.
How much difference does the debt/equity thing really make – aren’t we just substituting creditors for shareholders here?
Anyway, I wasn’t really arguing that the German/Japanese model was the way forward in all regards – only that they have more long term investment. If we agree that the best way of stopping CEOs from taking the piss is to have some shareholder oversight, then that probably means Germany/Japanese firms have more efficient rates of executive pay.
There’s a bigger argument to be had about which is the better system overall – I’m just saying that one of the points against the UK/US system is that it seems to let CEOs extract rents more easily.
@Perry. With regard to BP/Haliburton, how about anarcho-corporatism then? The point is that the disregard for safety, equipment checking and so on, shows that this is not a model of business that should continue. The scale of the unfolding ecological disaster in the gulf has been well documented on George Washington’s blog and the oil drum, the details aren’t pretty.
I don’t understand your second point at all. Are you saying that a CEO who gets a huge bonus via inflation should be applauded?
As an investor in the mining sector there are a large number of companies I could invest in, some of them are run by highly ethical people, some are run by monsters. I’m quite happy to have a slightly lower profit if it means workers are trained well and dangerous chemicals are properly managed.
I don’t want to invest in a company where a miner dies every month and cyanide is chucked in the rivers.
If you really believe that ethics are ‘regulatory statism’ then I feel very sorry for you, for it means you have given up your humanity. I know a lot of people who are like that, they spend a lot of time alone with their money and no beauty in their lives.
No kidding but this is probably the funniest thing directed at me I have read in ten years. I honestly mean it.
You think that support for regulatory political systems that spew out vastly acres of regulations, all helped along by well funded corporate and special interest lobbyists… is somehow a measure of a person’s “humanity”. Well I suppose an obsessive desire to control other people is indeed a common trait amongst ‘humanity’, come to think of it so maybe you are on to something.
Seriously, this is beyond parody. You have made my day 🙂
And presumably more state involvement = safer and more ‘ethical’ businesses then, yes? And therefore companies with REALLY a lot of state involvement, like say in China, must be super extra ethical, what with all these selfless regulators making sure that no one poisons the pandas, eh?
Jim, companies don’t have “ethics”; only people do. If the people running a busines are ethical* their company will be, too. However, I would posit that a strong regulatory scheme, in which politicians and bureaucrats determine what is permissible, is antithetical to an ethical business climate, because business managers will assume (with reason) that anything up to the limit of the regulations is permissible and thus ipso facto “ethical”. The decision as to what is ethical has thus been off-loaded onto government, so the business manager bears no responsibility for it. The end result is the weakening of any sense of a need for personal business ethics; why bother, when the regulators have taken on that responsiblity?
It’s the same problem I have with governmental “charity”: it diminishes in the general public any sense that charity is their individual responsiblity. Why contribute to “worthy causes” when the government is already taxing you to do so? Society is weaker as a result. It’s the social analog to Gresham’s Law that “bad money drives out good.” Here, “bad” (in the sense of governmentally-imposed” ethics (and charity) drives out “good” (internally generated).
The regulatory imposition of ethical standards is ultimately self-defeating.
* By which, obviously, I mean that their sense of ethics and morality reasonably matches that of the observer (you, in this case).
There are three issues that ‘excessive’ exec pay raises.
1) Is it really excessive?
In most cases I would say yes. The market for top execs is dysfunctional. It is very small, many of the candidates are coming to the end of their career so do not have the same incentives as younger candidate might, who are still in the reputation building stage of their career.
Furthermore, shareholder activism is a joke. The salaries and bonuses are awarded by management for management. Shareholders are obviously less incentivised to prevent exec pay raises than execs are to push for them. Shareholders are also in a much weaker position than management in the negotiation stakes.
Also, it denies plausibility that top CEO’s are of a better quality than the top management consultants. For sure, these can also make handsome salaries and bonuses, but they are more of the order of £1m per year than £5-10m.
2) Is it damaging?
In most cases probably no, although exec compensation is not a trivial part of many companies costs. The outsize rewards are a function of the large risks that management are taking with shareholder money. It is a symptom, not a cause. Of which more later.
3) Is it fair?
As libertarians the only answer is ‘so what’. Our beliefs do not stem from a belief that the markets always get it ‘right’ but that a free market based society is the only society that is free, which is what matters. In fact, one of the great benefits of a free market society is that failure is allowed, and not kept going by subsidies.
So what should be done? Nothing, directly. However, having plowed half way through Kevin Dowd and Martin Hutchenson’s book ‘the Alchemists of Loss’ about the financial crisis I am convinced that revoking the limited liability law would do much to prevent ‘excess’ corporate remuneration, at least through bonuses awarded on the back of profits generated through short termist risky activity, or sheer manipulation of accounting profits.
Equity holders typically have the ability to vote their shares in AGMs, other meetings, so they can hire and fire and vote down boards, etc; bondholders, typically, have a more passive function.
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But it would appear that shareholders in German and Japanese firms have relatively fewer powers than they Anglo-Saxon cousins; there does not appear to be much “oversight”; in fact, I recall people such as Will Hutton claiming how great it was that Japanese and German firms did not have to worry about producing great quarterly results to keep shareholders happy.
I still don’t quite get how people regard CEOs as “rent-seekers”; the availability of CEOs of talent is, of course, relatively scarce but that scarcity is not something artificial. If these CEOs are such underperformers, then what exactly is preventing better ones from getting the job?
I’d also repeat my point about the need to chop away at hidden and up-front tariffs, corporate welfare, etc, so as to increase competitive pressures on big firms and make it easier for smaller firms to enter a market, etc.
I’d also question whether ending limited liability is a solution; some forms of LL might still exist even without active government intervention in an economy;p the principle of limited liability is too valuable to be easily tossed aside.
There are (as many above know) two reasons why shareholders find it very difficult to hold managers to account.
Firstly the vast web of regulations (especially in the United States) that limits shareholds (i.e. owners) powers over corporate managers.
And then there is also the fact that indivdual shareholders own (in the United States and Britain) only a small minority of shares anyway.
When I was born (yes I know the dragons still ruled the Earth) most shares were still owned by individuals – that is certainly not true now.
Pension funds and other such own them – i.e. hired managers are in control of other hired managers (sitting on each other’s pay boards and so on).
The primary reason for this is tax law – specfically the high rate of personal income tax, and even more the existance of inheritance tax and Capital Gains Tax (indivduals pay these taxes – trusts and corporations do not).
Yet the left want to INCREASE all these taxes – and they claim to be anti “fat cat” corporate manager.
It is a con – they left have always SUPPORTED the use of state policy to undermine owners and support managers (because that pushes companies step by step to a position where control by the state is easy).
That is why such things as the family ownership of so many German manufacturing companies is vital – and why inheritance tax (if recent moves to give it teeth work) are a knife at the throat of the German economy. Already that vampire Warren Buffet has been seen in Germany (remember how this man works – he goes to a the owner of a company and says “when you die the state will take much of the value of your enterprise in inheritance tax – but if you sell out to my corporation now, you can put the money IN TRUST for your children….”).
Still political companies……
Take two recent examples:
In Britain Sir V. Blank virutally wiped out the shareholders of Lloyds bank in order to buy the bankrupt HBOS because “my friend Gordon” (the then Prime Minister Gordon Brown) asked him to. What could individual shareholders do about this?
Nothing as they only owned a small minority of Lloyds shares – and the measure was presented to shareholders when it was already a done deal anyway (the owners had no way to control the managers IN ADVANCE).
In the United States General Electric has just announced that it is to make the General Motors “Chevy Volt” the company car.
This is not in spite of the Chevy Volt being crap – it is BECAUSE the Chevy Volt is crap, the managers of General Electric are worried that the Chevy Volt will fail if they do not buy lots of them.
But G.E. does not own G.M. – so why should the managers of G.E. care about how many Chevy Volt cars are sold?
They care because their loyality is to the government (who do own G.M. – i.e. really Government Motors) not to the shareholders of General Electric.
And what can the shareholders of General Electric do about this?
Nothing – apart from sell their shares.
I do not believe there is anything anti libertarian about the corporate form – as long as everyone is open about that form (i.e. customers and supplyers know they are dealing with a limited liability enterprise IN ADVANCE).
However, the AngloAmerican model of the corporate form, i.e. a web of government regulations protecting managers from shareholders and tax law that makes indivdiuals own only a small minority of shares anyway, is a model that is terrible.