Fat cats: a market solution for a market failure

Big business’s refrain over executive pay is so well-rehearsed it has become a mantra the rest of the workforce can probably recite off pat. These people work exceptionally hard and take risky decisions that should be rewarded just as failure will be rewarded with the sack. There is a global market for talent and businesses must pay the going rate. And whatever one feels about the payments it should be up to shareholders, not ministers, to set boardroom pay.

Well up to a point, Lord Copper – or perhaps more accurately Lord Browne who received £3.3m last year for his job of running BP. In fact arguments about rewards for success do not hold water. Research by the Work Foundation, an apolitical organisation, shows chief executive faces less risk of losing their job than their workers. One in seven companies changed CEO over the last year compared with one in four of their workers. With executive pay rising 28 per cent a year they certainly have little incentive to leave of their own accord.

Nor do the penalties for failure look that steep. The Work Foundation could find only one chief executive who was made redundant and he left with a £5m pay-off. An ordinary work can expect 0.58 per cent of their annual pay – or two days pay. Of course the UK is part of the globalised world. But while that has led to a fierce war between companies to hire the best executives, the opposite is true further down the ladder.

Thousands of workers have seen their jobs outsourced to countries such as India. If the job itself can’t be moved, companies are happy to bring in workers from Poland. This used to apply to plumbers and call centre workers but now affects lawyers, bankers and architects. With unemployment rising it won’t be long before it becomes an issue at the ballot box.

Sadly shareholder power is a myth when it comes to executive pay. The pay packages are set by non-executives directors who themselves are executives at other companies. The typical shareholder is no longer Sid of British Gas privatisation fame, but giant investment bodies that hold large chunks of the voting power of FTSE companies.

Over the coming weeks some £18bn of bonus is handed out to a select bunch of workers. Half of that is heading towards workers in the City of London. Even leaving aside the City of London, the rate of increase of the rewards for the directors of the largest UK companies has far outstripped those of their employees. Research by another apolitical research body, Incomes Data Services, shows the gap between the boardroom and the shop floor has doubled since the start of the decade.

The TUC looks intent on making 2007 the year of the backlash against executive pay. It points out that while company pay packets have doubled after inflation since 2000, ordinary employees have enjoyed a rise of just 6 per cent. Brendan Barber, its general secretary, has called for a national debate. Frankly that is a bit feeble. There are strong economic arguments on both sides over which there will never be an agreement.
Critics highlight the “obscenity” of such a wealth divide which appear to have no justification in productivity and which has created a parallel economy particularly in the London housing market. Advocates of a free market will warn that deterring successful managers and entrepreneurs coming to the UK will simply weaken the economy in the long run.

The fact of the matter is that pay is an issue of public policy. What is needed is action rather than more debate. The Government sets a minimum wage and makes it clear what wage increase it thinks lowly-paid nurses and teachers should get. The spotlight must now fall on the top earners.

This Government should be praised for doing more than its predecessors force boardrooms to be more accountable to shareholders. The failure of the current system is not the size of the sums involved – although those can be breathtaking – but the lack of a link between what they earn and the performance of their companies. No one sensible is calling for a maximum wage or a punitive tax.

There are two first steps the Government and the companies themselves must take. Terms of service should be cut to ensure departing directors cannot claim vast sums in lost earnings. Allied to that, boards must make basic pay a smaller share of the total package and increase the amount linked to performance targets. In the US basic pay makes up just 16 per cent of remuneration. The equivalent figure in the UK is 59 per cent.

That's a market solution. Surely bringing executive pay in line with performance is following free market rules to rather than upsetting them. That City can't argue with that.