Executive pay: when common sense makes good business sense

The CEO of a large company in the US earns on average 289 times more than the median worker. [1]

Since the Global Financial Crisis, executive pay has been a recurring and divisive topic. The fact that Richard Fuld, the “Gorilla of Wall Street”, CEO and Chairman of Lehman Brothers, walked away with several million dollars after the bank’s collapse, at the height of the subprime mortgage crisis, encapsulates the stereotype of overpaid managers with a short-sighted leadership.

To contextualise this multifaceted matter and suggest some constructive proposals, it is important to understand why public sensitiveness to executive pay is so high and focus on the policies implemented by governments to placate criticism.

Even among those opposed to high pay, concern is selective. Why are not entrepreneurs, sport and entertainment stars so scrutinised and criticised for the money they make?

One reason could be that top managers executive compensation packages are often so complexly structured that it is difficult to identify a clear, indisputable link between what they get and their contribution to the firm’s success [3]. Such link is easier to grasp for other well-paid figures who possess exceptional talents or create a product or service which did not previously exist.

Most of top managers’ remuneration is indeed opaque. Salaries are based on so-called Long-Term Incentive Plans (LTIPs): a mix of fixed and variable pay, bonuses, shares and stock options. Edmans suggests that cash and shares (with a long holding period) would represent a value-creating way to simplify LTIPs. [3]

Being unable to understand and justify high pay, journalists, social media influencers and activists attack the moral basis of what they perceive “as over-generous rewards from the market economy” [3] – something rather irritating, considering that, in many Western societies, the middle class has not seen its condition improving in the last decade. [4]

Although politicians have ridden the protest wave, [5] [6] [7] governments have mainly been inhibited in their policy response, being cognisant of the little gain a precipitate initiative may bring. In Italy, a pay cap was established only for senior managers in the public sector. [8] In the UK, the focus was on increasing transparency. Companies with over 250 employees were asked to disclose annually the ratio of their CEO’s pay to the median, lower and upper quartile pay of their UK employees. [9]

A more decisive action was taken by the Netherlands and the USA, which adopted a Say-on-Pay rule: the general meeting of shareholders must approve the remuneration policy and any amendments to it. [10] [11] This principle also constitutes one of the pillars of the recent EU Shareholder Rights Directive. [12]

It is likely that, as the evidence on the effects of these policies emerges, companies will need to cope with an increasing regulation in this space. In the meantime, they should anticipate potentially stricter requirements by embracing best-practices, such as employee representation on boards and remuneration committees, less byzantine LTIPs and a more detailed disclosure of pay structures.

The stakes are high. On one hand, excessive executive pay undermines public trust in business and in the market economy; on the other hand, recognising and rewarding a person’s talent is a key pillar of liberalism. Organisations need to reconcile these forces and can do so only through a proactive and collegial approach. When it comes to executive pay, common sense may make good business sense.

By Pietro Marchesano

Sources

[1] Harvard Law School Forum of Corporate Governance, 2018. The CEO Pay Ratio: Data and Perspectives from the 2018 Proxy Season. Available here: https://corpgov.law.harvard.edu/2018/10/14/the-ceo-pay-ratio-data-and-perspectives-from-the-2018-proxy-season/

[2] The Economist, 2020. Cutting the pie. Executives are rewarded handsomely. Available here: https://www.economist.com/business/2020/02/20/executives-are-rewarded-handsomely

[3] Shackleton, 2019. Top Dogs And Fat Cats. 1st ed. London: London Publishing Partnership.

[4] OECD, 2018. OECD Employment Outlook 2018. OECD Publishing, Paris. https://doi.org/10.1787/empl_outlook-2018-en

[5] FAZ, 2017. Brauchen wir ein Gesetz gegen die Gier? Von Tillmann Neuscheler. 22 February 2017. Available here: https://www.faz.net/aktuell/wirtschaft/wirtschaftspolitik/managergehaelter-braucht-es-gesetze-gegen-die-gier-14887535.html

[6] Reuters, 2018. Elezioni, Salvini: no a tetti manager pubblici. Giancarlo Navach, 12 February 2018. Available here: https://it.reuters.com/article/topNews/idITKBN1FW1XZ-OITTP

[7] The Times, 2018. No one should get a £1m salary, says Tory minister Caroline Nokes. Kate Devlin, 22 November 2018. Available here: https://www.thetimes.co.uk/article/no-one-should-get-a-1m-salary-says-tory-minister-caroline-nokes-llq9sjnxx

[8] Repubblica, 2017. Pa, la Consulta "salva" il tetto da 240 mila euro per gli stipendi. Economia e Finanza. Available here: https://www.repubblica.it/economia/2017/05/26/news/pa_la_consulta_salva_il_tetto_da_240_mila_euro_per_gli_stipendi-166491234/

[9] UK Government, The Gazzette, 2020. Executive pay ratio reporting: what do you need to know? Available here: https://www.thegazette.co.uk/all-notices/content/103469

[10] Van der Elst and Lafarre, 2017. Shareholder Voice on Executive Pay: A Decade of Dutch Say on Pay. European Business Organization Law Review volume 18, pages51–83 (2017). Available here: https://link.springer.com/article/10.1007/s40804-017-0065-3

[11] Harvard Law School Forum of Corporate Governance, 2019. CEO Pay Trends Around the Globe. Available here: https://corpgov.law.harvard.edu/2019/02/03/ceo-pay-trends-around-the-globe/

[12] European Union, 2020. EU Shareholder Rights Directive. Available here: https://eur-lex.europa.eu/summary/EN/uriserv:l33285