Executive pay rows show that governance matters

The contract between business and wider society has broken down

John Plender

By unhappy coincidence, the row unleashed by institutional investors over executive pay at Royal Mail last week came just after the unveiling of the UK’s newly revised corporate governance code. It was a salutary reminder that egregious boardroom pay awards remain endemic despite repeated reform efforts on both sides of the Atlantic.

An underlying message that should also be heeded is that abstruse matters of corporate governance and company law can have explosive political and economic consequences, most notably through their impact on inequality. Bad governance is an under-acknowledged factor in the populist tide that threw up US president Donald Trump, Brexit and much else besides.

Admittedly, the connection between flawed governance and inequality is not straightforward. In the UK, income inequality as measured by the widely used Gini coefficient rose considerably in the 1980s when the Thatcher government was dramatically reducing income tax rates. Inequality has since fallen, though it remains well above its 1970s levels.

Looked at in terms of the share of the top 1 per cent, the British plutocratic elite saw a rising income share from the late 1970s into the 2000s, but the trend then reversed a little after the financial crisis. Yet wealth inequality has since been greatly increased by the Bank of England’s post-crisis bond buying, which boosted the price of assets held mainly by the better off.

Moreover, as Charles Dumas, author of a compelling new book on the economics of populism argues, it is people’s perception of their relative position rather than actual financial loss that matters — not least perceptions of inequitable sharing of the pain in the 2007-8 financial crisis, where bankers continued to draw bonuses while in receipt of bailout money from the taxpayer.

Here, too, more recent boardroom pay episodes at such companies as Persimmon and WPP have reinforced the impression that business is run by a greedy, self-serving plutocracy.

In the US, inequality is more extreme. The Gini coefficient has risen pretty consistently since the late 1960s to the present day, with the top 1 per cent hogging the bulk of the income gains of the past three decades or so. The trend has been exacerbated by redistributive taxation from the poor to the rich, first under the George W Bush administration, now under President Trump. Wealth inequality has increased markedly since the late 1970s partly thanks to stock awards to top executives at a time when ordinary people’s incomes have been stagnant. This has been accompanied by a huge widening of the gap between chief executive and average employee pay, which bears no obvious relation to improved corporate performance.

It is also economically damaging. Economists at the IMF point to “the tentative consensus in the literature that inequality can undermine progress in health and education, cause investment-reducing political and economic instability, and undercut the social consensus required to adjust in the face of shocks”.

All this, says Deborah Hargreaves, founder of the High Pay Centre, leaves many feeling the system is rigged by a greedy business elite that has imposed globalisation and trade liberalisation on a populace that discerns no benefits. These feelings endanger the corporate sector’s licence to operate as public faith in business and even capitalism itself is thus eroded.

Flawed corporate governance is responsible for a different form of inequality, that between the corporate and household sectors, which damages the world economy. A lack of management accountability to shareholders in parts of Asia and especially Japan has encouraged an excess of savings over investment by business. With too much income bottled up in the corporate sector there is a shortage of household income and thus spending power in the economy. This has contributed to global imbalances and to increased debt in the US, UK and elsewhere.

A similar lack of accountability afflicts Big Tech in the US, thanks to two-tier voting structures that protect founding entrepreneurs from effective oversight. This encourages a hubristic culture, which helps explain why Google faces a €4.3bn antitrust fine in Europe for abusing its power in the mobile phone market. It is also one reason why Facebook was slow to confront privacy issues around its users’ data and Apple to address smartphone addiction.

Perhaps the most fundamental question in relation to corporate governance and the wider economy concerns the shortcomings of limited liability. As Mr Dumas argues in his book, this Victorian invention ensures that a company and its owners have only limited exposure to damaging consequences of their actions. Yet the implicit contract behind limited liability — companies pay tax in exchange for limited exposure — has broken down because globalisation has turned corporate taxes into an increasingly voluntary levy. Limited liability also contributed to excessive risk-taking in banking before the 2007-8 crisis.

Amid all this potent governance arcana, a substantial reform agenda clearly needs to be addressed.

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