The story of executive remuneration is about nothing if not unintended consequences. Well, of course it’s also about obscene and generally unjustified levels of pay forked out to a very well-placed group of people who suffer sociopathic levels of entitlement.
But let us look at the issue of unintended consequences and executive pay. Way back in the 1990s the US government became concerned about the rapid increase in executive remuneration and decided to use tax regulation to restrain what it regarded as excessive levels of pay.
During president Bill Clinton’s watch the tax system was altered so that any cash payment over $1 million (R9.2m at yesterday’s rate) would face hefty tax penalties.
That reasonable enough attempt to introduce some restraint into the process of rewarding executives marked a historic point in the story of executive pay.
With cash payments constrained by tax considerations executives turned to “tax-efficient” share options to boost the level of reward. The levels of pay that had given rise to the US government’s concerns were quickly dwarfed by the massive profits that executives were able to pocket as a result of their share option awards.
And when the generosity of the share option-based remuneration system became apparent it was rapidly adopted by companies across the globe.
Not only was it a great way of complicating tax matters but it had the added advantage of having a veneer of almost scientific determinism: executives could argue that their options were only valuable because the underlying shares had appreciated in value.
That appreciation was assumed to be entirely due to the efforts of the executives. The use of share options, in unnecessarily obtuse performance-related schemes, had the further considerable advantage of obscuring the actual amount of money that ended up in the hands of executives.
Over the next 15 years or so, the unintended consequence of Clinton’s tax move probably amounted to an “excess” payout to executives across the globe of more than $1 trillion. “Excess” over what was necessary to pay these executives to do their jobs properly and “excess” over what they were really worth.
The next unintended consequence followed the decision to force disclosure of executive pay. This happened in South Africa in 2001. Again the push for disclosure was based on the thinking of reasonable people. They assumed executives would be sensitive to public perception and would want to ensure their packages were restrained and justified.
The unintended consequence was that disclosure ensured packages were neither restrained nor, despite some extreme mental gymnastics by remuneration consultants and committees, justified in the eyes of the public.
All that mattered for 100 percent of executives of listed companies was that their pay level was among the top 10 percent of remuneration packages.
Although having 100 percent of anything in the top decile defies the laws of statistics, the situation was sold to the public as representing the workings of the free and effective market for executive talent.
It is because of these unintended consequences that I am a little restrained in my enthusiasm for the EU’s proposal to cap bankers’ bonuses at twice their salary.
The abuse of the bonus system is where most of the rot in executive remuneration lies. It has led to the creation of unnecessarily complex and arcane systems of reward and, certainly in banking where “long term” is defined as three years, has encouraged dangerous levels of risk taking.
The EU’s proposal is excellent and rightly deserves to be extended to the fund management industry.
Indeed, given that the banking sector led all others in the upward surge in remuneration packages, it is reasonable to assume these sort of restraints will be imposed, voluntarily or not, on other sectors. And, eventually, in other countries.
Switzerland, which can hardly be regarded as a hot bed of socialism, has already introduced far more radical curbs on corporate pay in all sectors.
And as we wait to see the unintended consequences resulting from the EU’s proposal we will no doubt be reminded that these consequences are evidence of the powerful underlying market forces.
It is, of course, much more likely they are evidence of the unmitigated power executives have to game the system.