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Wednesday, January 25, 2012

Reining in Corporate Pay: Europe as a Model of Fairness for America

Corporate compensation—executive pay in particular—represents a “clear market failure,” so said Vince Cable, the business secretary in the E.U. state of Britain. While suspected, the sheer explicitness, or blatant manner, of this verdict is itself noteworthy. Moreover, it stands as an opportunity for the E.U. to surpass the U.S. on economic fairness, which is a type of justice (see John Rawls). That is to say, Europe had an opportunity at the time of Cable’s statement to set the E.U. on a trajectory that would make the unfairness in the American system more transparent.

The business secretary, a Liberal Democrat in a coalition government with the Conservative Party, told the British House of Commons in January 2012 that business and investors “recognize that there is a disconnect between top pay and company performance and that something must be done.” In New York at the time, the disconnect was generally taken as a fact of life, given the power of the managerial elite in corporate capitalism (as well as American legislatures). As if attempting to pop this stygian balloon filled with the noxious air of denial, Vince Cable continued, “We cannot continue to see chief executives’ pay rising at 13 percent a year while the performance of companies on the stock exchange languishes well behind . . . (a)nd we can’t accept top pay rising at five times the rate of average workers’ pay as it did [in 2010].” The unfairness, in other words, is at the expense of not just the corporation’s owners, but also the (other) employees—executives being employees too.

It could be argued that the 13% annual increases in executive pay are a function of an increasing proportion of company stock options in the compensation. If the profits are languishing, the theory goes, the value of the options should be zero (i.e., unexecuted). However, what if the next group of executives, or even the economy over all, “performs” such that the options held by the previous executives then become valuable? Moreover, what do options cost non-management stockholders in terms of dilution? I suspect that options are “an easy way out” relative to cash compensation. The question is thus whether the practice can be reined in.

Under Vincent Cable’s proposals, shareholder votes on executive pay would be binding. Seventy-five percent, rather than a mere majority, would be needed for approval. I have never understood why the American states limit such votes to “non-binding,” as if the business judgment rule trumps property rights on compensation. Given that CEOs typically control their boards, whose job it is to oversee the executives for the stockholders, treating the property owners of the corporate wealth as if they were a focus group or a meaningless straw poll in Iowa seems misguided at best—and supportive of an institutional conflict of interest centered on the executives. To be sure, the suggestion made by Chuka Umunna, Vincent Cable’s counterpart in the Labour Party, to have employees as part of executive compensation committees also incurs a conflict of interest—one centered on the employees who have an interest in wanting “payback” for the decades of unfair compensation. Conflicts of interest can work both ways—inflating and deflating deserved compensation.

My main point is the following: Were Europe to strengthen investors’ property rights—including disallowing proxies held by managements for such votes on account of the conflict of interest—the fault running through American political economies and civil societies would become more transparent (i.e., more obvious). “We have  been clear that executive pay must always be fair and transparent, and that high pay must be for outstanding, not mediocre, performance,” John Criby of the Confederation of British Industry—a business lobby group—said. “Millions [of pounds] for mediocrity does a disservice to the reputations of hard-working businesses.” Indeed, it does a disservice to the society as a whole—particularly in terms of what it stands for. Can you imagine the U.S. Chamber of Commerce coming up with such a statement? It is a pity, particularly in terms of systemic risk, that a lack of enlightened self-interest in the vested interests on such a “clear market failure” exists in America. For this reason, “Europe as a Model” is not such a bad thing, certain rhetoric (of the usual suspects) to the contrary.

In Vermont and Wisconsin at the time of Vincent Cable’s speech in Britain, movements were underway to amend the respective constitutions (as well as that of the U.S.) to make it clear that corporations are not “legal persons.” I believe it would follow that money is not speech, though the amendments ought to make this explicit, given the tendency of justices to invent legal doctrines and the sway of money in legislative halls. Polls at the time showed 71% of the people across the United States were opposed to the Citizens United (unlimited corporate political contributions) decision of the U.S. Supreme Court two years before (almost to the day). Lest those movements get cocky, their leaders should be aware that huge corporate “war chests” used to buy politicians, commentators, and air time may mean that even such a supermajority’s popular will may not be sufficient. If so, it is unlikely that anything like Vincent Cable’s proposals would see the light of day in America. Accordingly, I have pointed out here the value in merely having an alternative displayed in Europe, even if the benefit is limited to wakening Americans up to the grip of corporate capitalism in American societies.

Julia Werdigier, “British Government Works to Rein in Corporate Pay,” The New York Times, January 23, 2012. http://dealbook.nytimes.com/2012/01/23/british-government-looks-to-rein-in-executive-pay/