The false economy

The false economy

Democratise companies to rein in excessive banker bonuses

Bonus goes here. Encinalense, CC BY-SA

In times of austerity, one of few things that seems to be booming is the trade in wheelbarrows. At least, company directors at major corporations will need them to collect vast amounts of remuneration they continue to award themselves, with the help of ineffective remuneration committees.

The financial dealers on Wall Street have collected about US$26.7 billion in bonus payments, the equivalent of a year’s pay for the 1.1m workers on the minimum wage. The UK is not far behind. Bonuses in the City of London have increased by 49% compared to 2012, a higher figure than for Wall St.

The chief executive of the crisis-ridden Cooperative Bank, Euan Sutherland, was to receive a remuneration package of £3.5 million, but has since resigned. The state-owned Royal Bank of Scotland declared a loss of about £8 billion, but has given 11 directors a bonus package worth about £18.25m between them. At Barclays and Lloyds Bank, the chief executives could be collecting more than £7m each. Of course, wheelbarrows come in handy at other corporate boardrooms too. Despite the costs arising from the Deepwater Horizon disaster, the pay packet of the BP chief executive has tripled to US$8.7m (£5.2m).

The corporate boardrooms are addicted to bonuses, but are the bonuses justified? The claims for bonuses and excessive rewards presuppose that executives exert superhuman efforts to generate wealth. The anatomy of corporate decisions does not really support that. When a new executive arrives at an organisation, for some time s/he is likely to be managing and living off products, services and strategies already in place. So the claims of distinctive contribution are hard to sustain.

Now suppose an executive decides to launch a new product or a project; this will always take some time to develop, plan and launch. The same applies if the mission is to rescue an ailing business. The success or failure of the new projects will not be known for many months or years. Meanwhile, the company will probably incur upfront costs, with no guarantee that the outlays will be recouped. Even after the initial celebrations, the product/service may turn out to be a failure and become a costly burden, as evidenced by payment protection insurance and other financial scandals.

Even if new ventures are successful, the success will depend on the involvement of other employees. It is hard to relate the success of anything to the efforts of few superstar executives. If the success cannot easily be related to the input of one person then the idea of performance-related pay becomes highly problematic. This suggests that higher rewards are claimed simply because some individuals or groups have sufficient power and control to give themselves disproportionate rewards.

So the question then is how to control the institutionalised fat-cattery. The UK government’s preferred solution is to empower shareholders by giving them a binding vote on executive remuneration. Such a step assumes that shareholders are owners of companies and bear most of the risks, and will somehow act in the interests of broader society. The evidence for this is not persuasive.

Shareholders in UK banks have average shareholding duration of about three months. Their position is no different from that of a speculator or a trader seeking short-term gains. They don’t have strong incentives to constrain directors. The UK Parliamentary Commission on Banking Standards looked at the operations of HBOS and concluded that shareholders did not exert “the effective pressure that might have acted as a constraint upon the flawed strategy of the bank”.

The commission also noted that “shareholders failed to control risk-taking in banks, and indeed were criticising some for excessive conservatism”. Shareholders often profit from harmful practices without any personal responsibility. A company can be mandated to sell harmful products, for example, cigarettes. Shareholders can share the resulting profits, but are not personally liable for because they are shielded by the doctrine of limited liability. Thus shareholder irresponsibility is written into the system and they don’t have strong incentives to consider the social good.

Besides, shareholders don’t provide most of the risk capital either. At major UK banks, shareholders only provide between 4.22% and 7.24% of total capital. The rest is provided by savers and creditors. Therefore, it is hard to make a good case for shareholder supremacy.

The proper approach is to empower the public. In the case of banks; employees, savers and borrowers are a good proxy for the public at large. They should appoint directors and vote on their remuneration. Elsewhere, employees, consumers and suppliers could be mobilised to invigilate directors as they all have a long-term interest in the welfare of the company. In a democratised company, directors are unlikely to get high remuneration without paying attention to the interests of employees and other stakeholders.

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