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Are CEO Bonuses Wrecking the Wider Economy?

Friday was a busy day for UK executives—dubbed "oligarchs" by some critics—as the bonuses they get and their effects on the wider economy once again came into the limelight.

On one hand, Barclays shareholders held their annual meeting, and 27 percent of them voted against pay deals awarded to Chief Executive Officer Bob Diamond.

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Barclays chairman Marcus Agius apologized to shareholders at the meeting for badly communicating the bank's policy on pay.

"There is a significant minority of shareholders who feel that we got some of these judgments (on remuneration) wrong for 2011 and that we have not sufficiently taken their views on board," Agius said according to Reuters.

On the other, the deadline for the business community to submit opinions on proposals by the UK government to make executive pay more fair expired on Friday.

That consultation process was launched in mid-March and tries to address growing public unhappiness at the fast growth in executive pay, with many critics saying it is not always linked to performance and some even warning that it will harm companies' and countries' long-term prospects.

The UK government's Department for Business (BIS) said in a paper on executive remuneration that the median total remuneration of FTSE100 CEOs rose from an average of 1 million pounds ($1.6 million) to 4.2 million pounds ($6.7 million) in the period between 2008 and 2010.

"This is more than a four-fold increase; significantly greater than the increase in the FTSE100 index, retail prices or average pay over the same period. This comes at a time where growth is strained across the rest of the economy," the BIS said.

Also this week, a new book about the bonus culture in the UK hit the shelves. Written by famous novelist and Conservative party member Ferdinand Mount, "The New Few: Or a Very British Oligarchy," looks at how power and wealth in the UK has been concentrating in the hands of a small elite while the rest of the country struggles.

In an editorial in daily newspaper "Evening Standard," Mount wrote that, for 30 years after WW II, the UK had become a more equal and open society but now "it is painfully obvious that social mobility has slowed again and a new super-class is soaring out of sight."

"Without knowing why or how, we seem to have hatched our own oligarchs, and we stand aghast and bewildered at this flock of monstrous cuckoos," Mount wrote.

Change in Corporate Behavior

He commended the UK government's initiative to give more control to shareholders over what bonuses are awarded, but one analyst said the changes in policy must go much further to reverse a harmful shift in the way companies operate.

The rise in the bonus culture, especially in the U.S. and the UK, has led to a "marked change in corporate behavior" that may, over the longer term, put those companies at a disadvantage compared with peers in other countries, economist Andrew Smithers wrote in a report headlined, "The Change in Corporate Behavior."

Not just the private sector is likely to suffer, Smithers argues. Bonuses awarded for short-term results rather than long-term business development measures are likely to force governments to keep spending in order to boost their economies, as companies refrain from making investment in order to deliver short-term returns for shareholders, rather than investing it for long-term gain, Smithers says.

He explains that business investment has been on a declining trend in the UK and the U.S., while profit margins have been rising, meaning that there is a savings surplus in the business sector that cannot be explained by the economic downturn alone.

Because the calculations behind bonus payments depend on short-term results, there is resistance to cuts in profit margins and to increasing investment, Smithers wrote.

"If no public pressure is exerted to change bonus systems, large fiscal deficits will need to continue if recession is to be avoided, at least until there is another change in corporate culture," he said.

According to Smithers, the change in corporate behavior due to the bonus culture has been "a major case of increasing disparity of incomes in the UK and US" which have seen "a large rise in the incomes of the highly paid at the expense of the rest."

Government policy should tackle bonuses as the cause of the savings surplus in the business sector and should set increases in output and investment among the requirements that would need to be met for bonuses to be paid, he wrote.

UK Government's Proposals

The UK government's proposals advocate an annual binding vote from shareholders on future remuneration policy, increasing the votes required on future remuneration policy, an annual advisory vote on how remuneration policy was implemented in the previous year, and a binding vote on exit payments over one year's base salary.

In its consultation paper, the BIS said that those measures would give shareholders more leverage on executive pay and would promote "a stronger, clearer link between pay and performance in order to prevent rewards for mediocrity or failure, while still allowing for exceptional performance to be rewarded."

Representatives of businesses have hit back at the proposals, saying that they would put UK companies at a disadvantage.

The Confederation of British Industry (CBI), representing around 240,000 businesses employing around a third of the private sector workforce, warned in a press release against what it said was "blurring shareholder and management responsibilities on pay."

The CBI also said that claims that there was no link between executive reward and company performance under the current system of awards were "misleading."

The Institute of Directors—an organization with around 38,000 members in the UK and abroad, comprising directors from various businesses—said it was concerned about the level of executive pay at "some of the largest UK listed companies."

"Out of control remuneration at some FTSE companies is damaging the reputation of British business as a whole. Giving shareholders a binding vote will help to rein in the excesses, and restore faith among investors and the wider public," Simon Walker, director general of the Institute of Directors, said in a statement.

However, Walker added that any new rules should be "properly designed" and that raising the number of votes on executive compensation beyond a simple majority is "flawed."

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