Former Governor of the Reserve Bank, Bernie Fraser, is the latest respected figure to take aim at excessive executive salaries. The former economist and Treasury secretary claimed last week that “greedy people and a slimy culture”, rather than market forces, are responsible for the drastic rise in executive pay.
Fraser was responding to one of the major reasons given by company directors and remuneration consultants for lofty executive salaries — that strong competition for talent drives executive pay. Directors argue that the pool of executives is limited and that high remuneration is needed to ensure shareholders get superior returns on their investment.
The elegance of this argument is that it is very difficult to disprove. CEOs have become the equivalent of a luxury handbag. In effect, the true genius of the modern-day CEO is not their ability to increase shareholder wealth by shrewdly allocating capital, but by marketing their own “executive” brand. Many executives are now the human equivalent of a Louis Vuitton purse — a victory of style over substance.
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However, as Fraser pertinently notes, the market for senior executives is certainly not “free”. Firstly, it is very difficult to determine the impact of a CEO on shareholder wealth. During the fifteen-year equity boom between 1992 and 2007, it appeared that executives were masters are creating shareholder wealth. As it has transpired this year, very few were, with share price jumps largely due to expanded price-earnings multiples and illusory debt-funded profits. However, even in 2007/08, despite significantly diminished shareholder returns, executives are still receiving record remuneration (executive pay for leading companies actually increased last year to an average of $2.97 million). In a functioning free market, the value of a product does not rise as its marginal utility diminishes.
In addition, rather than being determined by a marketplace of buyers and sellers, executive pay is determined by a clique of company directors — some of whom are close associates of the CEO they are paying (most CEOs also sit on the board of the company they manage). Further, in some instances, the executive played a strong role in hiring those directors. In other cases, the executive is on a Remuneration Committee which determines the general level of remuneration paid by the company. These factors are hardly indicative of free market forces at work. Rather, it resembles the Soviet Union, with the Politburo determining their own salubrious conditions while the rest of the population lines up for bread.
However, while the finger is often pointed at executives themselves for being “greedy”, it is slightly unfair to blame the recipient of monies. What reasonable person would ever reject money being offered to them? Rather, the fault lies completely with company directors (especially those sitting on remuneration committees).
It is up to company directors to ensure that executives are paid a reasonable amount. If an executive refuses a pay offer from a company, they should be shown the door, with the company announcing what the executive was offered, and that the offer was deemed unsatisfactory. Of course, such an act would take a large degree of bravery on the part of company directors and their highly paid remuneration advisors. Such bravery would most like diminish the likelihood that the directors and remuneration consultants will be asked to perform similar roles at other companies. When it comes down to a choice between protecting their own interests and the interests of shareholders, it is not difficult to determine where directors’ interests will lie.
It appears that company directors and executives are very much in favour of free markets, unless of course, it is in relation to their own remuneration.