19 June 2010
Today I wrote to the Financial Times.
Dear Sir,
I enjoyed Gillian Tett's article Ideas on curbing bankers appetite for risk (15/6/2010 on ft.com) about finding the best incentives for top bankers. I was also interested in Dr Steve Webb's letter (18/06/10) suggesting bonuses be paid in the bank's own long term debt, and requiring that this be held to maturity. My own proposals on executive rewards (Performance and Reward, Troubador 2006) was that payment be made in long term equity, which should be even more sensitive to excessive risks than long term debt.
However since writing that book, I have, like the New York Federal Reserve, come to realise that there are fundamental problems with linking bankers' rewards to profit or returns. The profound links between profit and risk mean that an incentive to increase profit is in fact an incentive to increase risk. Increasingly, because risk is subject to regulation, the incentive is actually to create hidden or understated risk, and this is even more dangerous in the longer term. The great complexity of the area means that there will always be clever people who can make a lot of money for themselves by circumventing or perverting the system. They have made their fortunes long before the world properly understands the dangers involved in what they have done.
This is why I now advocate a brutally simple global cap on bankers' pay. It is the only realistic way of curbing the risk appetite. Such a cap is not against enterprise or investment; rather it is to protect entrepreneurs, business owners and investors from the greed of their agents.
Yours faithfully
The Revd Patrick Gerard
Click here for the original article about a global cap on pay.
Click here for more on the problems of linking pay to profit.
Dear Sir,
I enjoyed Gillian Tett's article Ideas on curbing bankers appetite for risk (15/6/2010 on ft.com) about finding the best incentives for top bankers. I was also interested in Dr Steve Webb's letter (18/06/10) suggesting bonuses be paid in the bank's own long term debt, and requiring that this be held to maturity. My own proposals on executive rewards (Performance and Reward, Troubador 2006) was that payment be made in long term equity, which should be even more sensitive to excessive risks than long term debt.
However since writing that book, I have, like the New York Federal Reserve, come to realise that there are fundamental problems with linking bankers' rewards to profit or returns. The profound links between profit and risk mean that an incentive to increase profit is in fact an incentive to increase risk. Increasingly, because risk is subject to regulation, the incentive is actually to create hidden or understated risk, and this is even more dangerous in the longer term. The great complexity of the area means that there will always be clever people who can make a lot of money for themselves by circumventing or perverting the system. They have made their fortunes long before the world properly understands the dangers involved in what they have done.
This is why I now advocate a brutally simple global cap on bankers' pay. It is the only realistic way of curbing the risk appetite. Such a cap is not against enterprise or investment; rather it is to protect entrepreneurs, business owners and investors from the greed of their agents.
Yours faithfully
The Revd Patrick Gerard
Click here for the original article about a global cap on pay.
Click here for more on the problems of linking pay to profit.
Labels: bank debt, global cap, reward, risk, Tett
21 April 2010
Saving the financial system
I today left the following comment on ft.com, in response to an article by Martin Wolf, "Halting the Financial Doomsday Machine"
As you so pertinently point out, the incentives of those who run the system are the engine room of the doomsday machine. It is on the incentives that the really radical change is required. A global cap on executive pay (say US$500,000 per annum) would remove the incentive for top earners to prioritise personal gain. This would give more constructive motivations (such as saving the financial system) a real chance of being heard in the boardroom. Voters might well like to see a cap on pay, and it would free up lots of cash for the banks, allowing them to recapitalise.
And why not? The whole point of competition is to drive out costs and increase efficiency, but this has totally and completely failed in the case of the market for executive talent.
For more on the Global Cap on Pay follow the link in the left hand column of this blog.
As you so pertinently point out, the incentives of those who run the system are the engine room of the doomsday machine. It is on the incentives that the really radical change is required. A global cap on executive pay (say US$500,000 per annum) would remove the incentive for top earners to prioritise personal gain. This would give more constructive motivations (such as saving the financial system) a real chance of being heard in the boardroom. Voters might well like to see a cap on pay, and it would free up lots of cash for the banks, allowing them to recapitalise.
And why not? The whole point of competition is to drive out costs and increase efficiency, but this has totally and completely failed in the case of the market for executive talent.
For more on the Global Cap on Pay follow the link in the left hand column of this blog.
Labels: financial system, global cap, incentive
11 February 2010
Changing the mindset
On 7th February 2010 (on ft.com) the Lex Column of the Financial Times published a note on Executive Pay. This can be seen at:
http://www.ft.com/cms/s/3/28c6e0cc-1414-11df-8847-00144feab49a,s01=1.html
(Subscription may be required.)
I added the below comment:
Lex has precisely identified the problem with the “take one for the team”, “clubby remuneration committee” attitudes. The top people in business are now engaged in a game whereby they compete with each other to extract more and more value from the rest of the community. This is utterly wrong and completely unsustainable. A total change in mind set is needed. We need a global (or G20 wide) cap on pay from employments/directorships. This would promote and enforce the idea that an executive’s job is to work for the benefit of shareholders and wider stakeholders, not for his/her own benefit. This principle of fiduciary duty is fundamental to company organisation. Capitalism is doomed if we can’t get back to this principle.
More on a global pay cap at www.performanceandreward.blogspot.com
See links to "global cap on pay" and "Competition Law" in left hand column.
http://www.ft.com/cms/s/3/28c6e0cc-1414-11df-8847-00144feab49a,s01=1.html
(Subscription may be required.)
I added the below comment:
Lex has precisely identified the problem with the “take one for the team”, “clubby remuneration committee” attitudes. The top people in business are now engaged in a game whereby they compete with each other to extract more and more value from the rest of the community. This is utterly wrong and completely unsustainable. A total change in mind set is needed. We need a global (or G20 wide) cap on pay from employments/directorships. This would promote and enforce the idea that an executive’s job is to work for the benefit of shareholders and wider stakeholders, not for his/her own benefit. This principle of fiduciary duty is fundamental to company organisation. Capitalism is doomed if we can’t get back to this principle.
More on a global pay cap at www.performanceandreward.blogspot.com
See links to "global cap on pay" and "Competition Law" in left hand column.
Labels: club, competition, Fiduciary Duty, global cap
04 January 2010
Q&As on the Global Pay Cap - 1
Click here for the original article about a global cap on pay.
Click here for the global-cap-on-pay letter published by the FT, 12/12/2009.
Agreeing a global cap on pay and making it stick would be really tough - look how difficult international leaders have found it to agree anything on climate change. Is it feasible?
I agree that agreeing a global cap and making it stick is a tough challenge. However I can't help feeling that any less radical reform would not really get to the heart of the problem. Also, compared to climate change, a global pay cap has three big things going for it.
1) It is a simple concept.
2) It would be popular with voters.
3) It offers a cheap way of recapitalising banks
Like climate change there would be powerful vested interests working against it, but it is much easier to see it gaining rapid political momentum.
[Incidentally, if the pay of oil chiefs was capped and not affected by oil profits, then I suspect that oil chiefs would be far more ready to work constructively on the climate change agenda.]
Also we have to recognise that as the world gets more and more interconnected then there will be more and more need for global agreements. Truely international issues such as climate change and financial regulation really require international agreements. World leaders are going to have to get much better at delivering them!
To what parts of banking should the cap apply?
I agree that there are issues about where the cap should apply, but in the first instance it is very simple. Money made from someone investing his/her own money or growing his/her own business is not captured. Money made from other people's money or businesses is. All company directors and employees are working for a company and not for themselves so all wages and salaries, whatever form they are paid in, are all captured. All banking activities are clearly captured.
Where it potentially gets more difficult is with people like lawyers, accountants and consultants who are partners in a firm or have a company limited by guarantee, so they do make money from growing their own businesses. However it seems to me that this money should still be captured under the cap because they do not act as "Principals" but rather as "Agents" of their clients. They are therefore working for their clients and owe their clients a Fiduciary Duty.
The really fundamental issue that the cap is trying to address is making sure that "Agents" really do act as "Agents" and properly respect the interests of their "Principals". If agents are highly paid, or on performance related pay, then it suggests that they are working for their own benefit, not for the benefit of the Principal. This agency problem is a really deep problem. See http://en.wikipedia.org/wiki/Principal-agent_problem . It is also an ancient problem. Note that Jesus discusses the agency problem in his parables (e.g. Luke 16: 1-8). Alan Greenspan's comments on the cause of the credit crunch are very important. He says that in 60 years dealing with American business he had always assumed that companies worked to maximise the company interest, and especially to avoid their own destruction. However the risks taken in the build up to the credit crunch show that this assumption was no longer valid. Managers made the decisions that worked for managers, more than for the companies they managed. Part of the reason for this was the intensity of the competitive pressures than managers were facing.
Could not more be done to boost competition in the banking sector which is riddled with cartels and other practices aimed at artificially pushing up profits, and hence bonuses, at the expense of the customer?
I agree that there is a lack of economically effective competition in many sectors of banking. In the left hand column of this blog there is a link "Competition Law" which documents my efforts to get the Office of Fair Trading excited about the competition problems in the market for executive talent. Having said that, I no longer believe that more effective competition could ever solve the problems. The top people in society need to collaborate before they can compete. If they only compete then they pull society apart. Competition is certainly a big factor in the falling apart of the financial sector.
Are you aware of Stephen Green, Chairman of HSBC, and his work on banking ethics?
I am aware of Stephen Green through a Church Times article, but I don't know much about him really. I am interested in his book "Good Value"(although I am hopeless at reading!) HSBC is a good example of a bank that did not allow competitive pressures to distroy it. In the year before the crisis HSBC was under intense pressure from the activist investor Knight Vinke who thought HSBC should use its balance sheet more agreesively to improve "performance". I think HSBC was able to see through this because of its strong comporate culture and its emphasis on long term returns in the pay of top people.
Click here for the global-cap-on-pay letter published by the FT, 12/12/2009.
Agreeing a global cap on pay and making it stick would be really tough - look how difficult international leaders have found it to agree anything on climate change. Is it feasible?
I agree that agreeing a global cap and making it stick is a tough challenge. However I can't help feeling that any less radical reform would not really get to the heart of the problem. Also, compared to climate change, a global pay cap has three big things going for it.
1) It is a simple concept.
2) It would be popular with voters.
3) It offers a cheap way of recapitalising banks
Like climate change there would be powerful vested interests working against it, but it is much easier to see it gaining rapid political momentum.
[Incidentally, if the pay of oil chiefs was capped and not affected by oil profits, then I suspect that oil chiefs would be far more ready to work constructively on the climate change agenda.]
Also we have to recognise that as the world gets more and more interconnected then there will be more and more need for global agreements. Truely international issues such as climate change and financial regulation really require international agreements. World leaders are going to have to get much better at delivering them!
To what parts of banking should the cap apply?
I agree that there are issues about where the cap should apply, but in the first instance it is very simple. Money made from someone investing his/her own money or growing his/her own business is not captured. Money made from other people's money or businesses is. All company directors and employees are working for a company and not for themselves so all wages and salaries, whatever form they are paid in, are all captured. All banking activities are clearly captured.
Where it potentially gets more difficult is with people like lawyers, accountants and consultants who are partners in a firm or have a company limited by guarantee, so they do make money from growing their own businesses. However it seems to me that this money should still be captured under the cap because they do not act as "Principals" but rather as "Agents" of their clients. They are therefore working for their clients and owe their clients a Fiduciary Duty.
The really fundamental issue that the cap is trying to address is making sure that "Agents" really do act as "Agents" and properly respect the interests of their "Principals". If agents are highly paid, or on performance related pay, then it suggests that they are working for their own benefit, not for the benefit of the Principal. This agency problem is a really deep problem. See http://en.wikipedia.org/wiki/Principal-agent_problem . It is also an ancient problem. Note that Jesus discusses the agency problem in his parables (e.g. Luke 16: 1-8). Alan Greenspan's comments on the cause of the credit crunch are very important. He says that in 60 years dealing with American business he had always assumed that companies worked to maximise the company interest, and especially to avoid their own destruction. However the risks taken in the build up to the credit crunch show that this assumption was no longer valid. Managers made the decisions that worked for managers, more than for the companies they managed. Part of the reason for this was the intensity of the competitive pressures than managers were facing.
Could not more be done to boost competition in the banking sector which is riddled with cartels and other practices aimed at artificially pushing up profits, and hence bonuses, at the expense of the customer?
I agree that there is a lack of economically effective competition in many sectors of banking. In the left hand column of this blog there is a link "Competition Law" which documents my efforts to get the Office of Fair Trading excited about the competition problems in the market for executive talent. Having said that, I no longer believe that more effective competition could ever solve the problems. The top people in society need to collaborate before they can compete. If they only compete then they pull society apart. Competition is certainly a big factor in the falling apart of the financial sector.
Are you aware of Stephen Green, Chairman of HSBC, and his work on banking ethics?
I am aware of Stephen Green through a Church Times article, but I don't know much about him really. I am interested in his book "Good Value"(although I am hopeless at reading!) HSBC is a good example of a bank that did not allow competitive pressures to distroy it. In the year before the crisis HSBC was under intense pressure from the activist investor Knight Vinke who thought HSBC should use its balance sheet more agreesively to improve "performance". I think HSBC was able to see through this because of its strong comporate culture and its emphasis on long term returns in the pay of top people.
Labels: competition, global cap, HSBC, international, Stephen Green
11 December 2009
The case for a global cap on pay
Why a global cap on pay makes sense now
The argument for high pay is that businesses have to compete to secure the best talent. This is a real problem but it would disappear if all top business people worldwide were paid no more than say US$500,000.
Economists usually support competitive markets because competition forces out costs and increases efficiency. However competition has manifestly failed in the market for executive talent. Costs have spiralled, but the performance of the FTSE100 has been dismal since Dec 1999. In my opinion the failure of competition in the market for executive talent is caused by distortions in the market. The executives have considerable market power and there are concerted practices coordinated through remuneration consultancies. I have raised these concerns with the Office of Fair Trading (OFT). My dialogue with the OFT can be viewed by clicking on the link “Competition Law” in the left hand column.
Actually it seems to me that a truly competitive market in executive talent could never lead to efficient outcomes in appointing people to top posts. It is more likely to ensure that we appoint the most ruthless people to top jobs. We need to develop a culture in which top people are motivated by (or at least mindful of) their responsibilities to the rest of society. Money fuelled competition between top people inevitably pulls society apart in a destructive way. This has been seen most clearly in the financial sector, but it can also be seen in all sectors of society where pay has been used aggressively to motivate top people.
The purpose of the pay cap
The cap is not to get vengeance on bankers, although it might be politically popular for this reason.
The cap is not to raise revenue, although it will free up a lot of revenue in the banks, helping them to recapitalise.
The purpose of the cap is to solve structural problems in executive incentives. It addresses problems in executive motivation.
My recent blog post “bankers’ pay and the financial crisis” shows how performance related pay is profoundly flawed for top bankers because it colludes with a culture which assumes that the banker’s top priority is his/her own personal well-being, most tangibly his/her pay. In other words it encourages the top executive to put his/her own interests ahead of the interests of the company he/she manages. This is a recipe for disaster. Alan Greenspan could not believe that American Banks behaved in ways that were so destructive to themselves. The reason they did this was because the top executives were paid to look out for themselves. I have written a book on performance related pay for top executives (see link “View the book” on the left) but increasingly it seems to me that the goal of alignment between shareholder and executive interests is not realistic because it colludes with selfish desires on the part of managers and does not build a culture in which managers put the company interest first. It undermines the Fiduciary Duty on which our companies’ structures are founded.
A global cap on cap would go a long way towards eliminating selfish financial interests from the motivation of the top people in our banks and other companies. Once you reach the US$500,000 level you can go no further financially. You have to start looking for other forms of motivation. This will create space for more generous motivations orientated towards the good of shareholders, employees, suppliers and customers and towards the wider public good.
Who should NOT be captured by the cap
Wealth creators (entrepreneurs) should not be affected by the pay cap. People who make money by growing their own business, or investing their own money should be encouraged to do so. The cap would imply no extra taxation on capital gains caused by increased business value, and no extra tax on company dividends.
The public can have quite a lot of confidence that entrepreneurs who get rich have done so by creating real value in business (and so hopefully in society). It is much harder to have this confidence about someone who has got rich by being well paid. The entrepreneur makes no money until all employees and suppliers have been paid. Bank loans and corporate taxation must also have been paid. Only after all this money has gone out to other people does money become available for dividends to the business owner. Further the wealth created in this way is critically dependent on the long term success of the business. The incentives are therefore for long term corporate successes. This contrasts sharply with the banking bonus culture which gives rise to incentives which are short term, individualistic and independent of the long term interests of the institution.
Company owners must be encouraged to take their profits out of businesses as dividends not as salaries. Only in the former case can we be sure they are creating business value.
Who should be captured by the cap
The cap on pay should apply to people who are officially working for the interests of others, not for themselves. This certainly includes all company directors and employees. It includes everyone in government.
There are grey areas. Footballers are basically working for others; their club. Pop stars might be working for a record company, or they might have their own record company and be making their own sales. Film stars are probably working for a studio, but they may well be shareholders in their own film companies. Money (or value) received as salary, fees, pay, pension, bonus, share schemes, company cars, perks, etc. should all be captured by the cap. Money received by company owners as dividends should usually not.
Accountants, lawyers and consultants
Any work that requires a fiduciary duty to others should certainly be captured by the cap. Lawyer, accountants and consultants are therefore captured. Partners in big law/consultancy firms should not earn (or take home in profits) more than the cap, even if they are owners of the firm. This is because the same issues about incentives and motivation apply to consultants in respect of their clients, as apply to normal business executives with respect to their shareholders.
Consultants have massive incentives to build large and profitable firms/companies/practices which make money by providing services to other people or companies. Because the money is made by working for others it must be caught in the cap, even though it might be paid out to partners as dividends. This is important because without it consultants have an incentive to increase the scope of their work for the client and to build dependency in their clients. A consultancy business is likely to want to grow its size and profits, but the public need to be satisfied that this is really happening for the benefit of the consultants’ clients, and not just at their expense. One example is computer consultancies who have incentives to sell vast and unrealistic computer projects to governments. Another example is remuneration consultants, as described in Performance and Reward (The book – see link on left) pages 152 to 156. In fact in the case of lawyers, accountants and consultants there is a case for a much lower cap on pay so as to avoid undesirable incentives and to strengthen fiduciary duty.
The problem of loopholes
There is a danger that a great deal of effort and talent will go into looking for loopholes in the pay cap. People will try to restructuring jobs so that they are paid separately by several different companies or in different counties. They will restructure normal pay to look like dividends. They will try to seek pay through their expenses. They will try all manner of tricks. It is very important that all such tricks must fail quickly and firmly.
Loopholes in the cap could be extremely damaging. If executives sense a loophole then very perverse incentives might arise, and very destructive behaviours might be encouraged. Executives must be so clear that there are no loopholes that they do not waste effort looking for them. The law therefore needs to be very strong. I would suggest three aspects:
1) An obligation on companies to be able to demonstrate simply (i.e. without the use of a computer model, or long remuneration reports) that the total value of all their pay to any individual in any period of 365 days does not exceed the cap. The obligation should be so strong that most companies will find that the most convenient way of paying their top employees is a simple cash payment of 1/12th of the cap each month. All value transferred from the company must be included: salary, bonus, share option, pensions, benefits, club memberships, private financial advice, cars, private use of company jet etc..
2) An obligation on individuals not to receive more pay than the cap. Seeking to structure business activities or payment arrangements to avoid the cap must be an offence. Fines for looking for loopholes must be big enough to ensure that there is no incentive to do so.
3) An obligation of tax authorities to search for pay that exceeds the cap, and to tax it at, say 200%.
How will people respond to the cap?
I believe that top executives first reaction will be to look for ways around the cap. This activity must be firmly discouraged, as discussed above. There will also be an increased interest in getting money out of companies through different kinds of fraud. Vigilance must be maintained.
If there appears to be no way round the cap many executives, and bankers in particular, will feel extremely demotivated. There will be a huge motivation problem. The effects of this problem will turn out to be far less serious than they initially appear, because it is only selfish motivation that is being curtailed. Motivations arising from doing things for other people, or because they are worthwhile in themselves will still be retained.
Really talented people, who really do want to get seriously rich will leave employment and establish their own businesses. This will be a very good thing.
Many people who are not so sure that they can make money as entrepreneurs are likely to retire prematurely to enjoy the money they have earned. This will also be a good thing.
People who remain in top jobs will do so because they are interested in the job, because they think it is worthwhile and because they want to do good things for shareholders and other stakeholders. They will be far more ready to prioritise company interests over their own. Fiduciary Duty will be strengthened and companies and institutions will start to look much stronger. This is the real reason for making the change.
There will be increasing interest in making top jobs attractive in ways that do not involve higher pay; shorter working hours, more holidays, and better staff restaurants etc. This will be a good thing.
Several thousand people will have their earnings capped. These people will no longer be competing with each other for better pay. It is likely that they will still compete for reasons of power and prestige, but a great deal of the heat of competition will disappear. Top executives will start to find it easier to work together, easier to like each other and easier to form constructive and rewarding relationships. They will start to enjoy work in a much fuller, more holistic way. New and imaginative collaborations will be born. This will be a good thing.
99.9999% of the global population will earn less than the cap and will not be affected. Many of them will still regard the cap as a very good level of pay and there will still be a lot of competition to get top jobs.
The motivation problem will lead to much simpler business structures and to a much slower and more gentle pace of life in financial centres around the world. GDP will initially fall but this will matter much less than might be expected, because the economic output that disappears will primarily be the output that selfishly favours top people. Its impact on other people will be much less. However, ordinary people will benefit enormously from a more humane and holistic business culture.
The argument for high pay is that businesses have to compete to secure the best talent. This is a real problem but it would disappear if all top business people worldwide were paid no more than say US$500,000.
Economists usually support competitive markets because competition forces out costs and increases efficiency. However competition has manifestly failed in the market for executive talent. Costs have spiralled, but the performance of the FTSE100 has been dismal since Dec 1999. In my opinion the failure of competition in the market for executive talent is caused by distortions in the market. The executives have considerable market power and there are concerted practices coordinated through remuneration consultancies. I have raised these concerns with the Office of Fair Trading (OFT). My dialogue with the OFT can be viewed by clicking on the link “Competition Law” in the left hand column.
Actually it seems to me that a truly competitive market in executive talent could never lead to efficient outcomes in appointing people to top posts. It is more likely to ensure that we appoint the most ruthless people to top jobs. We need to develop a culture in which top people are motivated by (or at least mindful of) their responsibilities to the rest of society. Money fuelled competition between top people inevitably pulls society apart in a destructive way. This has been seen most clearly in the financial sector, but it can also be seen in all sectors of society where pay has been used aggressively to motivate top people.
The purpose of the pay cap
The cap is not to get vengeance on bankers, although it might be politically popular for this reason.
The cap is not to raise revenue, although it will free up a lot of revenue in the banks, helping them to recapitalise.
The purpose of the cap is to solve structural problems in executive incentives. It addresses problems in executive motivation.
My recent blog post “bankers’ pay and the financial crisis” shows how performance related pay is profoundly flawed for top bankers because it colludes with a culture which assumes that the banker’s top priority is his/her own personal well-being, most tangibly his/her pay. In other words it encourages the top executive to put his/her own interests ahead of the interests of the company he/she manages. This is a recipe for disaster. Alan Greenspan could not believe that American Banks behaved in ways that were so destructive to themselves. The reason they did this was because the top executives were paid to look out for themselves. I have written a book on performance related pay for top executives (see link “View the book” on the left) but increasingly it seems to me that the goal of alignment between shareholder and executive interests is not realistic because it colludes with selfish desires on the part of managers and does not build a culture in which managers put the company interest first. It undermines the Fiduciary Duty on which our companies’ structures are founded.
A global cap on cap would go a long way towards eliminating selfish financial interests from the motivation of the top people in our banks and other companies. Once you reach the US$500,000 level you can go no further financially. You have to start looking for other forms of motivation. This will create space for more generous motivations orientated towards the good of shareholders, employees, suppliers and customers and towards the wider public good.
Who should NOT be captured by the cap
Wealth creators (entrepreneurs) should not be affected by the pay cap. People who make money by growing their own business, or investing their own money should be encouraged to do so. The cap would imply no extra taxation on capital gains caused by increased business value, and no extra tax on company dividends.
The public can have quite a lot of confidence that entrepreneurs who get rich have done so by creating real value in business (and so hopefully in society). It is much harder to have this confidence about someone who has got rich by being well paid. The entrepreneur makes no money until all employees and suppliers have been paid. Bank loans and corporate taxation must also have been paid. Only after all this money has gone out to other people does money become available for dividends to the business owner. Further the wealth created in this way is critically dependent on the long term success of the business. The incentives are therefore for long term corporate successes. This contrasts sharply with the banking bonus culture which gives rise to incentives which are short term, individualistic and independent of the long term interests of the institution.
Company owners must be encouraged to take their profits out of businesses as dividends not as salaries. Only in the former case can we be sure they are creating business value.
Who should be captured by the cap
The cap on pay should apply to people who are officially working for the interests of others, not for themselves. This certainly includes all company directors and employees. It includes everyone in government.
There are grey areas. Footballers are basically working for others; their club. Pop stars might be working for a record company, or they might have their own record company and be making their own sales. Film stars are probably working for a studio, but they may well be shareholders in their own film companies. Money (or value) received as salary, fees, pay, pension, bonus, share schemes, company cars, perks, etc. should all be captured by the cap. Money received by company owners as dividends should usually not.
Accountants, lawyers and consultants
Any work that requires a fiduciary duty to others should certainly be captured by the cap. Lawyer, accountants and consultants are therefore captured. Partners in big law/consultancy firms should not earn (or take home in profits) more than the cap, even if they are owners of the firm. This is because the same issues about incentives and motivation apply to consultants in respect of their clients, as apply to normal business executives with respect to their shareholders.
Consultants have massive incentives to build large and profitable firms/companies/practices which make money by providing services to other people or companies. Because the money is made by working for others it must be caught in the cap, even though it might be paid out to partners as dividends. This is important because without it consultants have an incentive to increase the scope of their work for the client and to build dependency in their clients. A consultancy business is likely to want to grow its size and profits, but the public need to be satisfied that this is really happening for the benefit of the consultants’ clients, and not just at their expense. One example is computer consultancies who have incentives to sell vast and unrealistic computer projects to governments. Another example is remuneration consultants, as described in Performance and Reward (The book – see link on left) pages 152 to 156. In fact in the case of lawyers, accountants and consultants there is a case for a much lower cap on pay so as to avoid undesirable incentives and to strengthen fiduciary duty.
The problem of loopholes
There is a danger that a great deal of effort and talent will go into looking for loopholes in the pay cap. People will try to restructuring jobs so that they are paid separately by several different companies or in different counties. They will restructure normal pay to look like dividends. They will try to seek pay through their expenses. They will try all manner of tricks. It is very important that all such tricks must fail quickly and firmly.
Loopholes in the cap could be extremely damaging. If executives sense a loophole then very perverse incentives might arise, and very destructive behaviours might be encouraged. Executives must be so clear that there are no loopholes that they do not waste effort looking for them. The law therefore needs to be very strong. I would suggest three aspects:
1) An obligation on companies to be able to demonstrate simply (i.e. without the use of a computer model, or long remuneration reports) that the total value of all their pay to any individual in any period of 365 days does not exceed the cap. The obligation should be so strong that most companies will find that the most convenient way of paying their top employees is a simple cash payment of 1/12th of the cap each month. All value transferred from the company must be included: salary, bonus, share option, pensions, benefits, club memberships, private financial advice, cars, private use of company jet etc..
2) An obligation on individuals not to receive more pay than the cap. Seeking to structure business activities or payment arrangements to avoid the cap must be an offence. Fines for looking for loopholes must be big enough to ensure that there is no incentive to do so.
3) An obligation of tax authorities to search for pay that exceeds the cap, and to tax it at, say 200%.
How will people respond to the cap?
I believe that top executives first reaction will be to look for ways around the cap. This activity must be firmly discouraged, as discussed above. There will also be an increased interest in getting money out of companies through different kinds of fraud. Vigilance must be maintained.
If there appears to be no way round the cap many executives, and bankers in particular, will feel extremely demotivated. There will be a huge motivation problem. The effects of this problem will turn out to be far less serious than they initially appear, because it is only selfish motivation that is being curtailed. Motivations arising from doing things for other people, or because they are worthwhile in themselves will still be retained.
Really talented people, who really do want to get seriously rich will leave employment and establish their own businesses. This will be a very good thing.
Many people who are not so sure that they can make money as entrepreneurs are likely to retire prematurely to enjoy the money they have earned. This will also be a good thing.
People who remain in top jobs will do so because they are interested in the job, because they think it is worthwhile and because they want to do good things for shareholders and other stakeholders. They will be far more ready to prioritise company interests over their own. Fiduciary Duty will be strengthened and companies and institutions will start to look much stronger. This is the real reason for making the change.
There will be increasing interest in making top jobs attractive in ways that do not involve higher pay; shorter working hours, more holidays, and better staff restaurants etc. This will be a good thing.
Several thousand people will have their earnings capped. These people will no longer be competing with each other for better pay. It is likely that they will still compete for reasons of power and prestige, but a great deal of the heat of competition will disappear. Top executives will start to find it easier to work together, easier to like each other and easier to form constructive and rewarding relationships. They will start to enjoy work in a much fuller, more holistic way. New and imaginative collaborations will be born. This will be a good thing.
99.9999% of the global population will earn less than the cap and will not be affected. Many of them will still regard the cap as a very good level of pay and there will still be a lot of competition to get top jobs.
The motivation problem will lead to much simpler business structures and to a much slower and more gentle pace of life in financial centres around the world. GDP will initially fall but this will matter much less than might be expected, because the economic output that disappears will primarily be the output that selfishly favours top people. Its impact on other people will be much less. However, ordinary people will benefit enormously from a more humane and holistic business culture.
Labels: global cap, incentives, motivation
