Tuesday 6 December 2011

Liberal Democrats and boardroom pay

This started out as a comment on somebody else's post, but it grew and grew. Nick Clegg has signalled the possibility of government action on high pay, and Charlotte over at DigitalPolitico says he's being “worryingly illiberal”. I don't see that. I think we need to be clear about what the issue is and about what a liberal response to it would be. Then in terms of a strategy there are two questions to answer. The first is does government have a right to interfere; the second is will it be effective.

As for what Nick Clegg has actually done, this is what the BBC website says: “The government is to publish new proposals to curb "unjustified and irresponsible" pay rewards in the private sector, Nick Clegg has said. The deputy prime minister said ministers would announce plans to "get tough" on excessive boardroom pay in January and may legislate if necessary.”

And this is what Robert Peston says: “... it is highly likely that companies will be forced to publish the numerical relationship between senior directors and other staff pay.

“But I would be staggered if any Tory prime minister and chancellor - even those who have repeatedly said that "we're all in this together" - would legislate a legal maximum for bosses pay.

“As for the other two proposals, on giving investors the formal power to block pay awards and on forcing the remuneration committee to have a workforce rep as a voting member, goodness only knows whether they will be enacted or squished.”

What problem is this action answering? It is not just high boardroom pay and a growing divide between top and bottom pay levels. If it were just that, I would be with Charlotte – there is no need to interfere and no rationale for interfering. (Just tax the rich buggers more and the poor buggers less.) It is more that boardroom pay, and traders pay in the financial sector, has become divorced from performance. People are paying themselves and their friends large sums of money which they have not earned. I have no objection (and I doubt very much if Nick Clegg or Vince Cable does either) to people earning very large sums of money. What I do object to is them being paid sums that they have not earned.

Should a Liberal interfere in such a case. Well, if it were just that I find it objectionable, the answer is no. People are free to do what they want provided it doesn't harm other people – the usual liberal principle. But this activity does harm other people. It puts money in directors' pockets at the expense of employees, shareholders and customers. Logically, employees, shareholders and customers should do something about that if they really care, but the history of this recession demonstrates, if it needed demonstrating, that they are not able to (and those that are able to, namely the representatives of large investors like pension funds, have been unwilling to, probably because those representatives benefit from the same gravy train).

It goes wider than that as well. This is not just a matter of distribution of spoils between a few people directly concerned with specific companies. These practices led to, or at the very least contributed to, the recession from which the majority of us are now suffering. This is actually a market failure, and it has become a prolonged and persistent one. In an efficient market, people get paid what they're worth. If people are paid more than their worth, their business loses competitiveness. The company loses market position, or those people lose their jobs and more effective managers come in. But this is not what is happening. People were being paid vast sums of money for poor performance before the crash – Fred Goodwin one of the most notable examples. (I would really enjoy being able to drive my company off a cliff and walk away with a pension pot the size of his.)

Generally speaking such a crash would be seen as a wake up call, the directors responsible for the bad decisions made that led to the various crashes around the world would lose their jobs, with little compensation, and new managers would come in and would manage better. But that is not what is happening. Directors are still getting paid very large sums, with little evidence that they have earned those sums. Directors pay in the UK went up 50% on average in the last year. The companies they work for are not performing 50% better than they were a year ago. You might argue that actually seeing 50% increase in profits is unreasonable in a recession, and what these directors have been doing is helping their companies ride out the storm better. I have not examined the figures in detail, but I will take a bet that if you compare companies that have given their directors large increases with those that have given their directors small increases, you will not find any difference in performance. No, they have not suddenly become 50% more valuable than they were last year, they have just waited for a decent interval before turning back to their old ways. The market has not worked in this case and is not working.

We often forget that markets actually rely on governments. Without government rule making, markets would not exist. Without the enforcement provided by national and international law, nobody would be able to trust that a contract would be honoured. Excessive rule making squeezes markets; effective rule making enables them. When markets fail, governments not only have a right to intervene, they actually have a duty to intervene, to enable the market to work again. The rules by which directors pay are set have become ineffective and unsustainable – they are very sustainable for directors, but not for the rest of us. And they need to change, so that the people to whom the money belongs, primarily shareholders, get the primary say in who is paid what.

So Nick and Vince are proposing changes to the rules. They are not proposing legal caps on directors' pay, which would be illiberal and ineffective. But they are proposing to change the balance of power by three possible measures. This summary comes from Robert Peston's blog quoted above.

to make shareholder votes on remuneration packages for directors binding, rather than advisory (as is the case now);
 to force big companies to include an employee representative on the committee that sets directors' pay (the remuneration committee);
 to force companies to publish the ratio of senior directors' pay to the typical or median pay in the company, and even (perhaps) to prohibit pay rises that bust a mandated threshold for that ratio.

These measures seem to me to be eminently sensible and liberal. I hope all three get enacted. I hope they will be enough to bring boardroom pay under control, and to see that directors earn what they are being paid. Boards, though, have been so careless and intransigent throughout the recession that I fear they will need their heads knocked together before their behaviour will change.

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