Overpaid and under performing

This is an interesting and important question. The first thing one can say about it that a search on Google yields little on this specific subject except relevant information provided by the National Committee on Employee Ownership (NCEO) in the US, discussed briefly below and, of course, the Mondragon experience. For information on this successful group of cooperatives in the Basque province of Spain see here. In recent weeks the widespread disenchantment with grossly excessive executive salaries has finally resulted in a flurry of opinions as to how this has happened and what to do about it. Indeed there has been much more criticism from senior politicians than is customary with such episodes in the past. Just recently it was discussed also at the G20 meeting where PM Kevin Rudd specifically described the trend as an untenable situation.

While it is argued that greed is the principal cause there are also other causes as well and plenty of justifications like the usual "Performance Pay" argument and "if you pay peanuts you get monkeys".

Early critics of the trend were Professor Ian Ramsay and myself in the early 1990s (Woldring, 1995). We both found that there is only a weak or, more often, no correlation between high executive pay and performance. Other researchers in the US and Australia have basically reached the same conclusion.

A justification within Australia has always been, "if we don't pay for talent it leaves the country". Where to? The US presumably. Not anymore perhaps, as many finance industry high fliers are actually coming back. However, that justification for spiralling salaries has never been very convincing. People migrate for many other reasons than just for doubling or tripling their pay elsewhere.

The causes of high executive salaries are many and varied. The "infinite wisdom" of the market place riding high in a time of economic rationalism; lack of preparedness by both major political parties to curb excessive salaries, probably preferring not to upset their corporate donors; weak boards; and lack of shareholder power are some of the explanations.

The endless, pious criticism from and moral exhortations by PMs and Treasurers has been singularly ineffectual in remedying the situation The recruitment head hunters have of course been great beneficiaries of the ever-higher packages in the shape of their own spiralling commissions.

Disconcertingly, there is little doubt that in Australia, as in the US, the Reward For Failure (RFF) principle can often be demonstrated as well as the amazing associated principle the Promotion of Proven Duds (PPD), both in the private and public sectors. We can be sure then that the highest paid are not necessarily the best at all.

With the growing financial crisis - and in Australia the superannuation crisis as well - finally the spotlight is on executive salaries and PM Rudd has even outlined some rather bureaucratic, regulatory ways to deal with it. No doubt there are still other ways that could effectively deal with the problem, like progressive taxes, greater power for the shareholders and more transparency.

In the UK ESOP News (The ESOP Centre, November 2008) reports that a "claw back" regime is being prepared "on both sides of the Atlantic" suggesting that foreshadowed performance bonuses will not be paid or may have to be repaid. This is also expected from the Obama Presidency as well as from European Commission.

While this is encouraging news the latest reports in the UK suggest that although the UK Government has bailed out several major banks, the "City" bankers (the Big end of Town) have nevertheless decreed that "bonuses will be paid as usual". Critics claim that the corporate elite culture there brooks no government interference in their extravagant remuneration practices - a pretty arrogant attitude.

But what about ESOPs? Employee Share Ownership Plans provide opportunities for employees to become co-owners in the business they work in. They were started in the US by Louis Kelso in the early 1980s. About 10 per cent of US employees are members of an ESOP there.

Since 1986 the Australian Employee Ownership Association, a local advocacy group, has endeavoured to persuade governments to introduce favourable tax legislation for broad-based schemes (www.aeoa.org.au). This development is still in its infancy in Australia.

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.