29 November 2016

The Government’s plans to curb high pay are a bad idea

By Kate Andrews

Government intervention for the sake of public appearances is rarely a good idea. So we should all remain sceptical towards – if not downright opposed to – the green paper produced today by the May administration, with the aim of curbing high pay.

The Prime Minister appears to have backed down from the more extreme proposals she made originally: the touted rule requiring the appointment of employee-directors was more or less abandoned weeks ago, and her plan to make shareholder votes on pay binding has been tabled as something to consider down the road.

These proposed interventions weren’t simply misguided – they ignored the plentiful evidence that these kinds of interventions fail to improve corporate governance.

The Volkswagen emissions debacle, one of the most spectacular recent cases of corporate governance, was not prevented or ameliorated by the presence of workers on the board. In fact, stand-offs between worker-directors and other board members are thought to have contributed to a “toxic” environment which helped matters spiral further out of control. (That’s without considering the previous scandals that failed to be defused worker representation.)

And while shareholders are certainly the people best placed to determine the appropriate compensation for a successful or failed CEO – due to their ownership of and investment in a company – mandatory binding votes come along with unintended consequences of their own.

As the Big Innovation Centre highlighted in its report on executive remuneration last Friday, binding votes could actually make shareholders less likely to be vote down a CEO’s salary. An advisory vote allows for a more honest discussion, while a binding vote encourages caution.

Yet despite retreating on these particular policies, the government is still emphatic that it will play some sort of role in curbing CEO pay – seemingly driven by public perception that said pay is too high.

The requirement going forward – that companies reveal the figures for their highest and lowest paid staff members – essentially relies on stoking public hostility as a means of forcing companies to lower salaries at the top end.

But this tactic stems from two false premises. First, it pushes the spurious idea the salaries are fixed; that there is a set amount of money in a pot somewhere, every penny of which is dished out in varying quantities to all salaried employees.

This is simply not how value is created or salaries are set – and it is disingenuous to suggest to workers that if the CEO were paid less, the money would be automatically redirected towards their own salaries.

As the High Pay Centre itself has pointed out, any link between high executive pay and in-work poverty “is no more than an intuitive theory”, rather than being based on evidence or research.

The other problem with this tactic is the assumption that high pay in itself has no merit: that it is a “problem” in need of a “solution”.

Over at the IEA, our most recent paper on public pressure for pay regulation, authored by Ryan Bourne and Prof Len Shackleton, highlights the problems with this attitude, and the consequences to businesses and the economy when pay becomes politicised.

In a globalised economy, the role of the chief executive has become significantly more important; the successes, failures and sudden departures of CEOs can increase or diminish a company’s worth by billions of pounds.

As our report noted, when Tidjane Thiam, the former head of Prudential. announced in March 2015 that he was moving to Credit Suisse, “Prudential’s shares fell by 3.1 per cent (a fall in value of £1.3 billion) while Credit Suisse’s shares rose by 7.8 per cent (£2 billion).”

The value added by uniquely talented individuals like Thiam – who have the rare foresight to know what gambles will pay off – can be immense. Top salaries allow companies to compete for the best talent around the world.

Our report also highlighted how interventions by government often fail to achieve their desired outcome in terms of curbing high pay.

In Germany, where government rules have required stakeholder representation in a two-tier board system, top levels of pay have actually increased – with some evidence suggesting top salaries in Germany have overtaken those in the UK.

On top of this, this government-imposed requirement of stakeholder representation is estimated to have cost these firms an astonishing 26 per cent of shareholder value.

If Mrs May’s government is concerned about public perception, she should make a concerted effort to simplify the tax system, including closing loopholes which benefit high earners, so the public feels secure that top earners are also the top contributors to the country they live in.

She could also address concerns around “crony capitalism” – often manifested in state favours, bailouts, and barriers to competition – under which government policy helps to protect salaries for a lucky few.

But she must also turn her attention away from the smoke-and-mirrors issue of high pay, and concentrate on the real problem: low pay, and the growing cost-of-living burdens that leave so many people feeling like a sustainable lifestyle is out of their reach.

Everything else is merely a sideshow – and one that will only distract ordinary workers from the larger issues at hand for so long.

Kate Andrews is news editor at the Institute of Economic Affairs.