Wednesday, 15 February 2012

Executive Pay - Your Questions Answered

Professor Simon Deakin, Programme Director CBR

1. Do bonuses and incentive plans work?

The real problem is that share options benefit executives in the event that the share price goes up and the Company does well, but if the share price goes down executives rarely see a fall in their pay and they simply don't exercise the share options concerned. It is pretty much a one way street for them and there is no real accountability to shareholders or to anybody else by these means.

2. Does shareholder accountability work?

There is a real misunderstanding here. Shareholders don't have the right to manage the company and don't have the right to give direct orders to the Board on matters like this. At the moment they are entitled to give an advisory opinion and that is really as far as it goes so there is a mismatch here between the reality of shareholder powerlessness in the face of what has become an accepted way to pay executives and the view of the politicians and others that if only shareholders could get their act together they could stop these practices. Basically they can't.

3. Is there a culture of short-termism?

The case for paying Stephen Hester, the Chief Executive of the Royal Bank of Scotland Group, is that he was brought in to do a specific job and this is the going rate for people of his position so it is unfair to focus on one person. In the case of Sir Fred Godwin, the former Chief Executive of RBS, the issue would be was one man really to blame for the failure of RBS and the government bailout? The question in his case was why policy makers, regulators and others allowed a bank like RBS to operate in the way that it did to be such an aggressive takeover bidder in the markets for corporate control and why the clear risks that the Bank was running were not taken on board earlier by the regulators?

4. Does naming and shaming work?

If in the case of RBS if there had been a breach of duty by the members of the Board the Executives and the non-Executives the right course of action would have been for legal proceedings to have been brought in the name of the Company against those Directors for a breach of duty or for the Directors to be disqualified under various regulations and to stop them practicing as Directors. That has happened in just one case, but legal action has not been taken against the others. The FSA said there was no case for taking action against Sir Fred Goodwin, the Company itself has presumably decided not to sue former directors for breach of a duty of care either. There are legal mechanisms for dealing with these issues. It is one thing for somebody to be singled out in these circumstances by others, when there are also legal routes that weren't taken for good reasons. Naming and shaming under these circumstances is simply wrong and unfair to the individual concerned.

The real issue here is that the law is inadequate. RBS wasn't well run and had been run for a number of years in a highly risky way sometimes those risks paid off, but eventually they didn't pay off and the taxpayer had to foot the bill for that. This is wrong but the error lies in the regulatory framework and in the view that Companies like RBS should have been active in a takeover market, that hostile takeovers are a good thing for all concerned and that the City and the UK benefits from being at the hub of this international global market for corporate control. Those are all serious errors but those are the errors of- to a large extent - policy makers, the City establishment and also of intellectuals and others who supported this line of work.

5. What else would work, I know you think we could use tax law, how would that work?

One reason why we have seen such great use of share options is because they were encouraged by the tax system. The tax system also encourages takeovers because it allows tax relief to companies where they take on debt which is often the consequence of a takeover or a private equity buy-out. The tax system has been driving hostile takeovers and has been driving private equity deals and it has also been driving share options. The tax system has been driving all the things that have been contributing to excessive risk taking in the financial sector in the run up to the crisis which began in 2008. It is not right to say this is just the consequence of particular corporate strategies or maybe of a particular individual like Sir Fred Goodwin. Policy makers systematically set out to encourage practices, through the tax system, that turned out to be very risky indeed and had a huge public cost.

6. Do we need a more fundamental reform of the legal systems in which boardroom pay is regulated?

For the past thirty years there has been a view that governments should take a back seat in all this and that by giving voice to independent directors, we could deal with the risk of corporate excess and of a lack of accountability. This was a false perspective. Shareholders can only do so much to control managers and if we have a government that just takes a back seat, and even worse if governments' just put in a place a tax regime and a company law regime that encourages the idea that a company should be engaged in the pursuit of shareholder value at all cost and hostile takeovers whenever possible, then what happened in 2008 will simply happen again. We do need a fundamental rethink of what the function and purpose of a big company like RBS is, are they just serving short term financial needs or a wider range of interests?

7. Do we need new laws?

We certainly do need new laws. We need a fundamental review of the way the corporate tax system operates and we also need a review of the way corporate governance is structured which gives an overwhelming voice to the shareholders at the expense of other stakeholder groups but also at the same time not giving those shareholders the power they think they should have to control managerial excess. The simple truth is that at the end of the day neither shareholders nor workers nor customers, these so called stakeholders, can control some of the corporate excess that occurred in the run up to 2008. We need much more effective financial market regulation, but it would certainly help if other stakeholders apart from shareholders were given a voice in corporate governance. Employee membership of remuneration committees is just a first step in this process, we should also be thinking seriously about employee representation at Board level.

8. Codetermination, can we look to other Countries and systems that work much better than our own?

We have rejected the idea here that workers should have a voice in corporate governance, their position has been completely marginalised. In Germany by contrast workers do have a voice they have Board level representation in big companies and they have representation on works councils on issues of workplace representation and this does engender longtermism and also a more co-operative approach to the running of big firms. We can see that this has very clearly benefitted the German economy and its productive base has remained very strong not withstanding globalisation.

The same is true of Japan which doesn't have formal codetermination but on the whole Boards of Directors do not think that their job is just to return value to shareholders. They think the job of the Company is to build up a productive organisation over the long term and to provide jobs and a high level of service for customers and consumers. The German and Japanese models have been very, very, successful in building up productive stable companies that provide jobs and support, public infrastructure and communities in those countries. We instead, have companies which support the City and engage in hostile takeovers sometimes successfully but very often not, and we have also seen the whittling away of our productive economy in the last twenty years.

9. Is more regulation now needed?

There is going to be a need for more regulation through the tax system and through Company law that is unavoidable. The question now is how to get that regulation right. The current government has quite rightly pointed to the need for pension funds to be more serious long term investors in such things as UK infrastructure projects and that is a really promising sign that this Government is taking these issues very seriously. They shouldn't be afraid of pointing to the mistakes of the past twenty or thirty years, we now know that some aspects of the 1980s settlement on the City, unravelled in 2008, so now is the time for David Cameron and George Osborne to really grasp this nettle.

Centre for Business Research, Top Floor, Cambridge Judge Business School, University of Cambridge, Trumpington St, Cambridge CB2 1AG
Tel: 01223 765320 .