Mar 15, 2015

Even if they fail, fat-cat bosses still get a big payoff

Most entrepreneurs are underpaid, but many bosses of big businesses are wildly overpaid. For example, the Financial Times reported recently that the 10 highest-paid FTSE chief executives earned £119m last year. That is more than 440 times the average annual British salary. The vast majority of such bosses are simply employees, hired hands running publicly owned companies, rather than founders who took a big risk to create a new enterprise. Can their pay packages possibly be justified?

The evidence is weak. A short but useful report was published last week called Made to Measure: How Opinion About Executive Performance Becomes Fact, written by David Bolchover. It discusses how much impact CEOs have on a big company, and asks how rare truly successful bosses are. There is almost no proof that there is a limited supply of brilliant leaders for existing institutions: in my experience, as Bolchover writes, “they are much more replaceable than their status and pay might indicate”.

Unfortunately the system is corrupted. Most plc remuneration committees are dominated by non-executives from similar boards — they are part of the status quo, and unlikely to rock the boat. Supposedly independent pay consultants are retained by executives, and it is in the insiders’ interest that everyone earns more. Bogus justifications for pay hikes are brought forth, such as ensuring executives feature within the “upper quartile”. This has the effect of an endless upward escalator for the lucky recipients.

The agent-principal problem looms large in all businesses owned by savers whose interests are represented by fund managers. Fragmented shareholder bases mean it can be difficult for individual investors to achieve change. Asset managers tend to be highly rewarded. Their average pay will outstrip that of investment bankers by 2016, the think tank New Financial reckons. So they might well be inclined to see huge salaries as perfectly acceptable.

According to a recent survey of members of the Institute of Directors, the issue of excessive pay is the greatest threat to public trust in business. HSBC’s embattled CEO received almost £8m last year and the Lloyds boss reportedly about £11m, despite the fact that the bank had to be bailed out by the taxpayer and is still partly owned by the state. Both lenders, like most large companies, are shrinking their payrolls and not creating jobs. Interestingly, surveys show people do not mind if entrepreneurs are well rewarded. They understand that creating a big business requires a rare talent, and owners should have the chance of hitting the jackpot.

There are various excuses trotted out for huge pay packages. The first is the assumption that pay must rise in line with the size of the undertaking. Why? In some ways running a large, established company is easier than running a tiny one. FTSE 100 bosses tend to have a vast infrastructure to support them — witness the way Lloyds carried on while its chief executive took months off work because of stress. By contrast, managing a fledgling business is truly testing: juggling roles, taking direct responsibility for many tasks — and risking bankruptcy. Typically, founders can barely afford to take holidays early on, unlike top chief executives who are ferried around by private jet or limousine. The worst that can happen to them is to be asked to “step down” with a juicy payoff.

A high proportion of the director mega- packages represent performance payments, frequently equity linked, remuneration experts argue. If these are long-term incentives then I approve, but normally they are a one-way bet for the executive concerned. In other words, there is no downside if the targets are missed. I think well-off bosses should have something tangible at stake, not just a “tails I win, heads I don’t lose” arrangement.

If anything, there is even more of a dilemma in America. Three books cover the subject well: Indispensable and Other Myths, by Michael Dorff; Money for Nothing, by John Gillespie and David Zweig, and The Halo Effect, by Phil Rosenzweig. They demonstrate how boards have failed to control CEO pay, while the disaster of celebrity bosses has compounded their error.

I am appalled that so few serious business leaders stand up to defend business and capitalism in a coherent way. They cower behind their PRs or bodies such as the CBI. I suspect most worry about having to justify their gargantuan pay if they expose themselves to the mainstream media. This leaves a vacuum all too often filled by academics and activists who lack credibility or just hate business.

Thank God many still take the plunge and start their own businesses, despite the prospect of earning less than they would in the corporate world. Luckily many able individuals prefer the freedom and independence of building a business — and society respects them for that. By contrast, it rightly despises fat-cat bosses who gorge at corporate troughs.