Politicians across the spectrum are faced with anger from the public in the UK, US and elsewhere over the widening earnings gap between the top quartile and the rest. Indeed within the top quartile the growth between the top 1% and the rest can create tensions of its own. Since the credit crunch in 2008, the main focus of public anger has been around banking and wider finance. However, there remain rumblings over Chief Executive Pay and the increasing multiples between the average worker and the board.
Politicians need to be seen to do something, yet many of the possible interventions could turn out to be as bad as the disease. The purpose of this short paper is to reframe the political debate into a set of potential policy options that would satisfy the need “to do something” while in the short term, at least, avoiding some of the long-term downsides that are clear whether in the “Blue Labour” camp or the “Crony Capitalism” school of thought.
Let me illustrate some of the challenges.
First, remuneration committees want to motivate their boards by setting targets for bonuses. Inevitably everyone sets targets in the top quartile of pay!. Who is going to be motivated by a target in the 4th quartile? So, the clear impression is given that as a CEO of company A. I sit on the remuneration committee of B. B’s CEO sits on my remuneration committee. Hence, the claims of “crony capitalism” are made.
So, in boom or bust, the gulf between the CEO and the average widens regardless of performance.
Regardless of political persuasion the idea of a “high pay commission” or the Treasury regulating CEO pay is a complete no go. The effect of this on new company formation, the ability of the UK to attract foreign investment and the like would be extremely dangerous.
In Finance, the payments of bonuses have increased dramatically over the last decade, while returns to shareholders have fallen. Yet the statutory duty of the board is to its shareholders. How can a company claim that it has its incentives aligned with its shareholders when bonuses have gone up over 100% while shareholder returns have fallen 40% in some cases?
So, the coalition proposes to give statutory rights to shareholders to vote down executive pay. Yet many of these powers have existed for years and have been used rarely.
The danger is that many of the institutional investors pay schemes are part of the crony capitalism story, so those voting on pension funds behalf for instance are being asked to be Turkey’s voting for Christmas.
The political rhetoric wishes to reward success and not reward failure. Yet politicians don’t want to have their hands on the lever of every board room decision. That reluctance is to be understood.
The failures outlined above, looking at this from a “systems” perspective and with future sustainability in mind, come from a lack of feedback loops to align reward with performance.
Government has one specific lever, Tax that potentially could provide that feedback loop.
Here, I want to float a number of routes that could be used to show that the political class was responding to the anger over high pay, while avoiding long-term involvement in the pay agenda.
I have chosen the examples here to illustrate “stories” that could be told, left, right and centre, to convince the public that government had acted, while not “killing the golden goose”.
First, align company tax rates, or part thereof with shareholders retunes, in terms of dividend payments and capital growth.
If shareholder returns increase, say 15%, then total discretionary pay for the organisation to cover all staff and executive, could increase 15% without additional taxation. If bonus payments increase 20%, then tax would be paid on the 5%. This inevitably would be dubbed an “overpayment tax”. If however, total bonuses went up 10%, the 5% could be banked. This would enable companies to retain staff during a down turn. It would also drive companies to think seriously about cycles It has the benefit that an entrepreneur who invests in a business over many years could realise the value on selling the company he created as the “underpayment” would be allowed against tax. It would support companies that planned for economic cycles and the long term against “short-term” approaches.
Now, this does not make such payments illegal, but the publication of the “overpayment tax” in the company reports would be a lightning rod for shareholder activists, who would get a double whammy unless they bought into the argument for these payments. Government hence avoids regulating top pay and the tax system promotes investment, growth, long term and cyclical thinking.
This also has other “benefits” to the political class.
The takeover of Cadbury by Kraft, was deeply unpopular. A lot of thinking has been going into changing the takeover rules because there is a lot of disquiet about how short term investors profited at the expense of “a great British Company” and its staff. Yet suggestions such as removing voting rights of new shareholders after a bid is announced break the link between the company and its shareholders. That is a difficult step to swallow.
The above tax approach would mean that bonuses paid for completing takeovers would be taxed unless the value of the takeover was realised. It is well known that many takeovers fail to deliver the shareholder returns promised in the bid document. It is interesting to speculate what affect this might have on the payments to advisory groups in Finance supporting M&A work.
Another example of this approach might lie with distressed companies.
The first part is public anger over payments to departing directors of failing institutions. Lord Simpson at Marconi and Sir Fred Goodwin at RBS are prime examples. Contracts that reward failure would be difficult to sell to shareholders in this approach.
So-called “flat-pack” administration was introduced to deal with legitimate concerns over the overheads and timescales of the old processes and their impact on potentially viable businesses that were in short term problems.
The difficulty is that many of these approaches are seen to be abusive of the spirit, but not the letter of the intention. The danger, particularly in the current economic downturn, is that wiping out the old shareholders and creditors could easily create a domino effect across the economy and worsen our troubled economy.
Consider a company with a share price of 50p but with an apparent book value of £2.50 per share. For a potential investor, or new CEO, if they were confident that they could turn the business round then buying the business or taking shares as bonus, would create a tax upside without government subsidies. Creditors, existing shareholders would not be wiped out and continuity of employment would be assisted. Indeed offering staff shares in a distressed company under new management fits the discussions of the “John Lewis” economy and employee-shareholder models.
The final piece of the jigsaw lies in the tax allowances against write-offs. Here, if a company was not allowed to write off against tax bad deals where bonuses had already been paid, then one of the current problems would be addressed.
The banks are today writing off massive losses against deals where large bonuses were paid in the past. This is where the central claims that gains are privatised but losses are socialised bites.
Small bonuses might be exempted, say in the range £10-£50K. Company accounts would then need to show how exposed they were to this potential claw back. In the short term, the behaviour of many organisations would be to pay all bonuses in shares to minimise tax and to align bonuses with shareholder returns.
The overall scenario paints what looks like a very strange picture. For the Government, success would mean that no tax would be raised through this avenue. This situation would mean that rewards were in line with contribution and performance. For the public, dependent on their pension funds, the sense of unfairness on the rewards would be, in theory, ameliorated.Inevitably, as with the flat-pack administration example above, once a policy framework like this was introduced, there are many who would crawl over the detail and not the spirit to find loopholes.
I am not, necessarily arguing for these specific policy tools. What I have tried to do is to come ito an internal logic to the blue Labour and Crony Capitalism, narratives and to design an outline of a policy framework and the safeguards against long-term government intervention into the system.
My belief is that something such as this model will evolve from the political rhetoric, especially as there is cross-party focus on these issues. That these same arguments can be found in the USA and elsewhere, suggests that this cannot be ignored. Hoping that it will go away is implausible wish-fulfilment.
Now once such a system as this was introduced, it would be subject to change and evolution that would create unintended consequences. What might they be? I would argue that if the above systemic approach is what you don’t want to happen, what will be needed is another construct that delivers to the agenda that I have outlined. Comments welcomed.