29 August 2017

Theresa May is wrong about executive pay


In an article for the Mail on Sunday, Theresa May has said that businesses who pay excessive salaries to senior executives represent the “unacceptable face of capitalism”. Such pay is “damaging the social fabric of our country”, she argued.

The High Pay Centre called the Prime Minister’s comments “a step in the right direction”, but said that more needed to be done to address the systemic issue of high executive pay.

It is certainly true that the top executives of large companies do tend to earn vast sums of money. For example, Ben van Beurden the Chief Executive of Royal Dutch Shell took home £7 million last year. Rakesh Kapoor of Reckitt Benckiser pocketed over twice as much at £14.6 million. WPP’s Sir Martin Sorrell topped the list with a pay package worth £42 million last year.

These are obviously huge sums of money and, when many ordinary people are struggling with the cost of living, questions about fairness and inequality are naturally raised. The pay of top executives is an easy target, and both Theresa May and Jeremy Corbyn have enjoyed positive media coverage when they have fixed their crosshairs on the issue.

However, these attacks on high executive pay are wrong for two main reasons.

First, such arguments ignore the fact that top executives deserve their high salaries because they are worth a lot of money to their companies. Take Harriet Green, for example. When she stepped down as the head of Thomas Cook, £400 million was wiped off the market capitalisation of the company.

Conversely, Microsoft became 7.5 per cent more valuable as soon as Steve Balmer resigned. There are many other examples of this. One is that of Tesco, which became £220 million more valuable when its CEO announced that he would become much more hands on. When Steve Jobs died, Apple’s value decreased by 5 per cent. As for Burberry, £536 million was wiped off the company’s value after Angela Ahrendts left the company. Clearly the market sees huge value in the work done by a good CEO. 

However, it is not just share prices that are impacted by their top executives. A review of the academic literature shows that the departure of a CEO can impact the performance of firms. For example, in their paper “Do CEOs Matter?”, Bennedsen, Perez-Gonzales, and Wolfenzon found that sales growth and profitability are negatively impacted by the sudden death of a CEO or one of their family members. This, according to their later paper, “Evaluating the Impact of the Boss: Evidence from CEO Hospitalization”, is also the case when a CEO is admitted to hospital. In “CEO Ownership and Firm Value: Evidence from a Structural Estimation”, Page found that firm performance increases when the CEO is perceived to be much more involved both in terms of investment and effort.

Therefore, it is patently clear that CEOs have a huge impact on the share price and performance of their company. The reason why they earn such high salaries is because that are worth a lot to their company.

The second reason why attacks on executive pay are wrong is because what a company chooses to pay its CEO is, quite literally, none of our business. Private companies are just that: private. These companies are owned, not by the public, or the government, or the media,  or (in most cases) the employees, but by shareholders.

It is therefore up to no one but the shareholders to decide what to do with the company’s money. Theresa May and the High Pay Centre may find it unpalatable that executives earn such high salaries, but it has nothing to do with them.

From Aristotle’s Politics, to John Locke’s Two Treatises of Government and Robert Nozick’s Anarchy State and Utopia, history’s greatest thinkers have defended and celebrated private property rights. As such, it is the owners of property who get to decide what to do with it, not the State or the media. Therefore, it is the shareholders who should decide what they do with their resources, if that involves  paying their CEOs huge sums of money, then so be it.

It is precisely because the shareholders grasp the fact that good CEOs have a positive impact on the value and performance of their companies that shareholders are prepared to pay such high salaries to their top executives.

What about the proposed fixes to excessive executive pay? Theresa May has proposed that companies which face a revolt over executive pay should be placed on a public register in order to shame them. Mrs May has pointed out that some firms have faced “shareholder revolts” over executive pay. However, in these situations it has been a minority of shareholders who have voted against remuneration packages. In fact, the Department for Business, Energy, and Industrial Strategy has defined “revolt” as 20 per cent. This is arrant nonsense for obvious reasons. Not least of all because it would be unjust for the votes of a coterie of shareholders to take precedence over the decision of the majority.

Such a proposal is patently wrong and it is also unnecessary. This is because, in a free market, if the shareholders are unhappy with the actions of their directors – including in terms of remuneration – they are free to take action, or to take their money elsewhere.

If enough of them feel strongly about this, then investment in the company will dry up, and the directors will have little choice but to change their policy on remuneration. Therefore, there is no need for the government to intervene, the market will do a perfectly good job by itself.

Theresa May is wrong about executive pay. CEOs have a huge impact on the value and performance of their companies and so deserve their high salaries. Moreover, it is not the government’s business what the owners of private companies decide to pay their employees. And not only is the Prime Minister wrong on the issue of executive pay, her potential solutions to the perceived problem are also misguided. 

Ben Ramanauskas is a Policy Analyst at the Taxpayers' Alliance