Overpaid and under performing

Could ESOPs be a curb on executive salaries? That would depend on many factors. If we think of co-operatives, as 100 per cent ESOPs, also typical of a high degree of industrial democracy, the directors and executives would not get away with excessive packages. Indeed the members would decide what their reward would be. In Mondragon the rule is that top managers should not earn more than six times the wage of the lowest employee. While managerial talent loss to the private sector in Spain has made this rule hard to enforce in recent years, the practice forms a stark contrast with traditional capitalist corporate culture.

In the capitalist corporation the board of directors comprises a set of like-minded corporate chiefs. Supposedly "independent", writers like Bebchuk, L and Fried, J. in (2004) Pay without Performance - The Unfulfilled Promise of Executive Compensation concentrate on the seriously flawed assumptions underpinning Agency Theory. They analyse and lament the lack of independence of boards, lack of systemic performance checks and the unquestionable weakness of shareholder power.

So, apart from an ESOP having the usual positive effects on employees' commitment, e.g. productivity, loyalty and income benefits, under what under what circumstances could an ESOP be a moderating and democratising instrument that would ensure:

1. equitable remuneration of the senior management in relation to the entire staff;
2. transparency of executive packages; and
3. effective checks on executive achievement.

First of all, the ESOP would have to be very broad-based. At present a high percentage of ESOPs are still executive type and generally highly lucrative. The percentage of take up would need to be increased very substantially.

Second, employee shareholders or their representatives need to be involved in the decision-making processes of the firm. There are many ways of achieving "Employee Voice", the Enterprise Councils in Europe are a good example.

Third, employees or their representatives must be able to propose the replacement of non-performing executives. After all, it their future that is at stake.

As far as Australia is concerned, where the problem of excessive remuneration exists, in large listed companies, employees own less than 2 per cent of the voting capital, without employee voice. Furthermore, all general shareholders, who in theory have control over remuneration strategy, can only comment on the remuneration plan presented at the AGM. The main shareholders are fund managers (e.g. super funds). Usually, these have either supported remuneration recommendations or have remained silent on them. Where they have voted them down boards have often taken no notice of it (E.g. Telstra), although some have. Fortunately in Small and Medium Enterprises (SMEs) excesses of executive remuneration are not common.

Encouraging broad-based ESOPs would require not only a culture shift in both management and employee attitudes in Australia but also in industrial relations. In the light of the current economic climate that is something that could happen, with Government assistance. The crisis is here and lots of things could actually change for the better as a result. The 2004 ESODU research found that overall only 4 per cent of businesses had broad-based ESOPs (meaning that it was open to at least 75 per cent of staff). There is clearly room for massive improvement.

In the US, where the incidence of obscene executive salary packages is highest, there is evidence that ESOPs, covering around 9 per cent -10 per cent of all employees, act as a break on executive remuneration. It should be remembered though that workplace democracy, European style, is not supported by legislation in the US and is not common. A combination of these two strategies would tend in the direction of the Mondragon experience, well known and admired.

The US National Centre for Employee Ownership (NCEO) has conducted a Survey on this topic Executive Compensation in ESOP Companies, November 2005. 98 pp. It can be found at here.

NCEO states: "this book includes a report on the first-ever survey of executive compensation in ESOP companies. The results strongly suggest that ESOP companies have a much more restrained approach to executive compensation than many of their non-ESOP peers. Executives in ESOP companies make less than their peers in similar non-ESOP companies, both in current and deferred compensation".

Also a series of articles about executive salaries and ESOPs in the US , collected by NCEO,  can be found at here.