French President Nicolas Sarkozy, in a speech to The World Economic Forum in Davos presents himself as a spokesperson for the anger (WEForum).
‘There are remuneration packages that will no longer be tolerated because they bear no relation to merit’
President Obama and Prime Ministers Brown and Rudd have all delivered some tough talk on the issue. Is this just political grandstanding? Does the size of executive salaries matter? Is the only serious issue rewarding people for poor, even destructive performance? There are ethical issues not least of which is financial businesses, like others, require a social license to operate and that is dependent on those businesses being beneficial and not harmful to society. As the system began to shut down, the benefits these businesses normally provide became very notable by their absence. However, the devil is in the detail: while economies and societies need a well functioning financial system, the participant businesses also place great stress on that very system when the profit motive is not kept within the greater ethical duty not to harm. One of the lessons of the current crisis is that when we are discussing complex systems with millions of daily transactions across the globe, it is very difficult to judge whether harm is being done, how much or by whom. In fact, one of the important causes of the crisis was the incapacity of risk assessment procedures and agencies to give an accurate measure of what the risks were which was further compounded by market-wide cultures addicted to risk. The central problem is that we do not know.
One of the ways that people ordinarily check to see if they are likely to be damaged by a commercial transaction when they do not know all the relevant facts is to attempt to run a rough "fairness" test on the transaction: they attempt to estimate who gains the most from the deal and very often if they judge that the other party is going to gain more benefit than them, that is, it fails the fairness test, they do not enter into the deal. The logic seems to be: "If it looks unfair then it is likely that something else is not right with the deal as well." In this light, the widespread anger against executive remuneration is understandable: suppliers, clients, employees feel aggrieved if they perceive some to be gaining a lot more from "doing business" than them. Executive remuneration packages fail the fairness test, leaving most people with the sensation, even conviction that they are being cheated by greedy people. After all, one definition of a greedy person is someone who seeks more than their "fair share" of benefit from a deal. These sorts of "tests" are very rough: most of us are working with inadequate information much of the time and we still have to make decisions. Another but related source of grievance is the sense of powerlessness. In an ordinary commercial transaction, I can decide not to buy or not to sell. However, it is more difficult to disengage entirely from a whole sector dominated by large institutions which are all paying such salaries.
Autonomy, being able to decide for one's self, being able to participate in decisions which affect one is very important to human beings. Respecting, enabling, others' autonomy, is for that reason a basic ethical principle. Respecting and building on their capacity to decide helps make people more effective also. People are most effective at work when they feel their input is valued by management. Autonomy requires both access to good information and the formal ability to make a decision.
In relation to executive pay, the complexity of packages means it is very difficult to know if one is being cheated or not. In the absence of better information, most will make that judgement by running what they know past their "fairness filter". A recent study shows that people are acutely aware of fair or unfair rewards within the workplace, especially when money is involved (Economist). While fairness as a rough test is useful, the detailed application of principles is contested especially in relation to salaries where the work performed by executives and shopfloor employees is so varied. The CEO of a top 20 Australian company earning 110 times average weekly earnings would need to be able to show the fairness of this by presenting a persuasive argument that his work is 110 times more valuable than a shopfloor employee (Productivity Commission).
The other aspect of autonomy, that is, formal participation in decision making, can help respond to the problem. However, that principle is also largely ignored while remuneration committees are staffed by executive and non-executive directors without the input of other relevant stakeholders, such as stockholders themselves and employees. There are strong arguments that the high levels of executive remuneration is not so much the market at work as the ‘clubbiness’ between top executives and the rather small population that make up boards. The other much suggested measure is to give stockholders voting rights over the packages. Certainly the consultative voting initiative in Australian public companies would suggest that institutional shareholders can and will object (ERC).
Unsurprisingly the highest executive salaries have been seen in the USA where chief executives of large Wall St Banks such as Goldman Sachs have benefited from bonuses of up to $67.9 million (Reuters). The government of President Obama has chosen to take advantage of the opportunity of the bail-out to limit executive salaries to $500,000 in those financiers which took tax-payer money. (Whitehouse). This cap though is essentially a temporary measure, companies either not in receipt of funding or who have returned the money are not restricted by this measure. Treasury Secretary Tim Geithner has flagged the possibility of shareholders having a greater say in setting executive remuneration through ‘say-on-pay’ legislation (Whitehoure). Measures such as this could address the lack of diverse stakeholder input into setting executive salaries. However, the legislation is bogged down in Senate Committees leaving President Obama limited only to encouraging banks to act ethically when setting remuneration levels (Whitehouse). Goldman has heeded the ‘political pressure for restraint’ this year in awarding its CEO a bonus of (only) $8.99 million, but until the lack of legislative clout is rectified President Obama can only hope his exhortations continue to be heard on Wall St (Reuters).
By late 2009 broad agreement was reached between banks and the government in the UK that action on executive remuneration was necessary and compliance with new rules would commence in 2010 (HM Treasure). According to the five banks involved this agreement was necessary ‘to make sure are staff are appropriately and competitively rewarded for sustainable, long-term performance’ (HM Treasury). The subsequent release of the Walker Review into UK Banks and other financial institutions makes 12 recommendations with regard to remuneration (HM Treasury).
Whilst these recommendations attempt to provide greater oversight and transparency with respect to executive salaries they nevertheless fail to address other ethical concerns. Recommendation 31 for example promotes disclosure of salaries for ‘high end’ employees but doesn’t question the initial process leading to these high salaries. No recommendation addresses the problem of the make-up of remuneration committees. Subsequent statements by Prime Minister Brown speculating that ‘if, as a result of the legislation, the pattern of bonus payments changes, then that would be something to be welcomed’ do not indicate great confidence in the effectiveness of legislation to promote greater attention to ethical setting of executive remuneration (Number 10).
In Australia, a review into the issue was made public in January 2010 (Productivity Commission). The report makes recommendations to improve the process of setting executive remuneration such as independent remuneration committees. Recommendation 2 certainly goes some way to dealing with the question of who makes the decisions but still leaves them in the hands of non-executive directors. Greater involvement of other stakeholders would also be welcome but the ability of shareholders to influence remuneration committee decisions via AGM votes, as per Recommendation 15, is a step in the right direction. Inquiry chairman Gary Bank seems to want to stay away from the question of fairness: ‘the reform package would reduce the likelihood in future of executive remuneration outcomes that shareholders find objectionable’ (Productivity Commission). The Australian government is due to respond to the report sometime ‘during the first quarter of 2010’ (Treasurer). Previous legislation dealing with excessive termination payments may indicate a willingness on the part of government to adopt the reports recommendations but, as in the case of The UK, these measures only go some way to addressing ethical concerns (Treasurer).
Ethical behaviour requires the cooperation of all reasonable stakeholders. Not only is stakeholder involvement important to respect the principles of autonomy, it also achieves optimal outcomes in the long term. A range of measures from political pressure, reviews and legislation have been used in an attempt to deal with public indignation about excessive executive salaries. Whilst some of these measures go some way to dealing with these concerns, overall they fail to address the crucial issues of stakeholder participation. The Australian Productivity Commission claims to reduce board ‘clubbiness’ but in all cases the decisions about executive remuneration remain in the hands of select stakeholders such as non-executive directors (Productivity Commission).
As to the issue of fairness, or greed, none of the measures attempt to deal in a concrete way with high salaries. Greater disclosure of these packages helps with the deficits of information but does not address the other problems (HM Treasury). The willingness of UK Banks to cooperate with government presents an example of the opportunity for greater attention to ethical principles, unfortunately the initiatives have not gone far enough. Stronger legislation is possible in this environment if governments want to ensure that the reasonable expectations of stakeholders and of tax payers are to be met.
