Long-Term Matters: Executive Pay
Why should investment professionals care about the ‘#Occupy’ protests? The majority of the public - ie, our customers - share some of the protesters’ views, even if they are not on the streets. One potent driver is the huge growth in income inequality over recent decades. With this comes disgust with politicians for being the primary ‘enablers’.
We should be grateful that the public has not yet seen that we, institutional investors, have also actively contributed by choosing to ignore intra-firm income inequality. Put in corporate governance jargon, investors have, often as a matter of principle, ignored quantum.
This situation demonstrates the disproportionate influence of the mind-sets and power of the ‘1%’, and the lack of thinking, learning and good governance in practice among investors.
Second, it shows that there is still a disconnection between what the public is encouraged to think it is getting from the investment world and what is actually ‘under the lid’.
Third, investors could easily become a much bigger part of the solution if concerned stakeholders were to act strategically.
Let me take each in turn. To paraphrase the UK Labour Party’s spin master, Peter Mandelson, investors have been ‘intensely relaxed about executives becoming filthy rich’ and, indeed, we have made a virtue about being uninterested in pay inequality and quantum. This paradigm, set by advocates of free market capitalism, has gone global and the only question we ask is “is executive pay aligned with shareholder value?”.
But even with this rather limited goal, we have failed miserably. Several of the original advocates of the shareholder value model, such as Alfred Rappaport, have rejected the current interpretations. With notable exceptions, most investors have not engaged intellectually, let alone acted on operational implications. Since rising pay inequality is the norm at the very firms that are supposed to be the guardians of executive pay, this may not be so surprising.
Of course, investors are not the sole advocates of this mind-set. The media has reinforced hero worship of ‘celebrity CEOs’ who are often corporate shareholder-value advocates. And academics have shown an astonishing lack of intellectual curiosity. For example, I know of no serious study into the effect of growing pay disparity on employee engagement, which is allegedly a core priority.
Similarly, experienced practitioners know that egregious pay deals are good indicators of weak boards, yet this link too has received little serious attention. Nor has it been for the lack of expert warnings about the impacts of pay deals that incentivise the wrong priorities and behaviours. According to the Bank of England’s well respected director of financial stability, Andrew Haldan: “The problem lies in serious imbalances between privatised returns and socialised risks… This calls for fundamental reform.”
To summarise, like the fantastic emperor’s cloak in the fairy tale, it has been ‘obvious’ that internal pay equity is ‘irrelevant’.
My second point is about the huge gap between what the public is encouraged to think it is getting from the investment world in terms of ‘stewardship activity’ and what is actually happening. Much has been made of Say on Pay in the US and the Stewardship Code in the UK, and they certainly have much potential. But the dominant insider narrative is that these are initiatives which will work but ‘just give them time’. There is little evidence this is true: time is not the key missing ingredient. Even more importantly, and given the very high levels of social disquiet, industry attitudes would seem to be more reflective of complacency or conflicted leadership intent than pragmatism.
Third, we are now very close to the tipping point, with several actors playing the child who says the emperor is naked. In a survey commissioned by St Paul’s Institute, even finance professionals think finance and corporate executives are over-paid. Clients of private equity firms are forcing through performance deals which are more aligned with the interest of end beneficiaries and this trend will spread to other asset classes. Unions are waking up to the fact that, through member-nominated trustees of pension funds, they are enfeebling workers without even delivering decent investment returns. Religious asset owners are being pressured not to let the secular investment service tail wag the dog on this investment belief issue. But perhaps the best indicators of the coming tipping point are the fact that the business-friendly website businessinsider.com has articulated the best case for action and even CNN has taken on the task of educating its viewers.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and President of the Network for Sustainable Financial Markets