Should governments regulate executive pay?
Well, there’s regulation and there’s regulation. The fashion in executive pay regulation for most of this decade has focussed on shareholder votes, either binding or non-binding. “Say on pay” started in the UK, and the Howard Government was a reasonably early adopter here. Sweden, Norway and the Netherlands went down a similar route, although the latter two went for binding shareholder votes. An effort by up-and-coming Illinois senator Barack Obama and Barney Frank to introduce non-binding votes in the US remains mired in the US Senate.
In November, Malcolm Turnbull proposed that we shift to binding votes here. Yesterday Lindsay Tanner sounded sceptical about it but didn’t rule it out. Both the Government and the Opposition talk big on executive remuneration but don’t seem in a rush to do anything serious about it.
Given non-binding votes have been available in Australia for four years, the current level of outrage suggests they have not acted as a restraint on executive remuneration. And in fact there’s a school of thought that argues greater disclosure and/or non-binding votes act to increase remuneration levels.
But there needs to be a good case for governments going beyond the current shareholder-focussed approach (Adam Schwab discusses termination payouts here) and directly intervening in remuneration issues, which in effect amounts to interference in private property. Regulation is rarely cost-free and can lead to perverse outcomes. The Australian Shareholders’ Association maintains shareholders are best placed to keep pay in check.
But perceived excessive executive remuneration, particularly at a time of rising joblessness, when business is seen as failing to provide its principal benefit of employment, will have long-term effects. Eventually political opportunists will try to take advantage of public anger, or governments will be forced to embrace ill-considered positions. It has already happened with gambling, which is why we have a populist like Nick Xenophon holding a swing vote in the Senate. What’s the bet Pauline Hanson raises this issue in her latest attempt to enter public life?
Nor is it always the case that shareholders’ interests align with those of the community. Just ask anyone whose shares have gained in value because the company announced sackings.
And the arguments against regulation don’t stack up. The evidence is very mixed on whether large bonuses lead to better company performance (try here and here for starters). The financial crisis has undermined — or more correctly blown away — the notion that high remuneration is essential to attract top international managerial talent, since the pacesetters in remuneration, the US and the UK, were at the very centre of the crisis and some of those countries’ highest-paid CEOs proved the most incompetent. In any event, it is likely to be several years before there’s once again a seller’s market for executive skills.
Regulation is easier said than done, however. The drafting of water-tight regulations capable of withstanding the determined efforts of executives and remuneration consultants to evade them, and their effective enforcement, would be significant challenges. Invariably, it would create perverse incentives and prevent appropriate rewarding of some successful executives. And ASIC and APRA would appear to have their plates full without devoting resources to checking whether Sol Trujillo deserves his millions for overseeing the tanking of Telstra’s share price and the gutting of its workforce.
The Greens, who have been pushing this since well before the financial crisis, have proposed a couple of approaches. The most recent was to effectively shame executives by requiring them to explain excessive remuneration if they retrench employees, which would have limited effect. Public outrage hasn’t slowed the growth in remuneration in recent years. They’ve also tried to amend other bills in recent months to require shareholder approval of termination payouts and link receipt of government assistance to curbs on executive salaries. Bob Brown has also recently considered removing the tax deductibility of executive salaries above $1m, meaning excessive salaries would no longer count as a business cost.
Linking access to industry assistance, tax rebates and other forms of corporate welfare to limits on salaries would represent an appropriate quid pro quo: if you need access to taxpayer largesse to run your business, then you should abide by community standards when it comes to rewarding executives. It might make the industry handouts in the Government’s ETS more palatable if companies could only receive free permits if they complied with Government remuneration guidelines. Retrospectively, too — if Don Voelte wants handouts for LNG, he can cop a big paycut.
A high income super tax, however, would avoid any problems of governments trying to judge appropriate remuneration levels for individual sectors or even companies. A tax rate of 50% for incomes over $1m pa would be a start. It wouldn’t raise a great deal of money but it could be hypothecated, say, to protecting employee entitlements (hypothecation is a dud idea in general but it is useful as a sales gimmick). It would also prevent populism and envy politics from creating pressures for genuinely counter-productive regulation.