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High pay is a symptom of diseased organisations

Fri, 12th Jun 2015

It’s high time to get past platitudes and hand-wringing about CEO pay – even if that leads in unexpected directions.

The more you look at the present situation, the more remarkable it is. You wouldn’t know it from the election, but current forms of executive pay are a (perhaps the) central economic and social policy issue faced by the UK (and US) economy – key to innovation, productivity, growth and jobs, as well as in what to do about growing wage inequality.  

As a recent report by the High Pay Centre (HPC) lays out, performance-related pay, ‘a firmly established practice at nearly every major UK-listed [and US-listed] company’, not only doesn’t but can’t work. But the case against the soaring salaries it produces goes far beyond unfairness and ineffectiveness in its own terms. The unacknowledged reality is that executives are receiving telephone-number salaries for acting as corporate Harold Shipmans, euthanatising the companies in their charge and systematically undermining the economy’s capacity to create full-time jobs and decent wages.

An exaggeration? Then consider this. The publicly-quoted corporation, the engine of capitalism for the last 150 years, is on its way out. Over the past decade and a half, on both sides of the Atlantic the number of publicly-quoted companies has halved. The reason is hidden in plain sight: corporations run for the short-term benefit of shareholders and highly incentivised managers are an evolutionary dead end. They do not invest enough in the future to survive in the long term. They underspend on research, capital equipment and human capital, and overspend – sometimes to the equivalent of 100 per cent of earnings – on dividends and stock buybacks for the sole benefit of shareholders. In short, they are dinosaurs.

Not surprisingly, the retreat of the public corporations has huge economic and social implications. On the one hand, their management-inflicted handicaps leave those that remain ‘ill-equipped to provide long-term employment, opportunities for economic advancement, and benefits such as health care and retirement security,’ in the words of US academic Gerald Davis. At the level of the whole economy, skewed investment (or non-investment) decisions by managers under the influence of perverse financial incentives are holding back innovation, job creation and growth. Look no further for the causes of dismal productivity and snail-like post-crash recovery – they are now structural, not cyclical, insists City economist Andrew Smithers. US academics such as Clayton Christensen and William Lazonick agree.

Yet here’s the other remarkable thing about runaway executive rewards: the completeness of their failure is only matched by the inability to curb them. In one sense this is not a mystery. Far from being an outrageous aberration, the pay dynamic, amazingly enough, is part of ‘best practice’, baked into governance codes founded on the idea that companies are run for the benefit of shareholders and executives need to be incentivised to do their bidding. Together, shareholder primacy and executive bonuses form the flywheel of short-termism and an instrument of corporate mass extinction.

Keynes once noted that 'the real difficulty in changing any enterprise lies not in developing new ideas, but in escaping the old ones'. All the assumptions our pay systems are based on are false or unprovable, and 30 years of not making it work is surely trying to tell us something. While differing on the remedies, every constituency the HPC researchers consulted on the subject – the Institute of Directors (credit where it’s due), the TUC, management academics, economists, investing institutions, even many remuneration consultants – agreed that the system was broken, couldn’t be allowed to continue and had to be replaced. But continue it does, and no one has a clue how to end it.

As Upton Sinclair famously put it, ‘It is difficult to get a man to understand something, when his salary depends upon his not understanding it’. So, given the lack of official appetite or proposition for change, what should our response be?

Well, suppose that, rather than wasting more time and effort fighting hopeless odds, we instead accept that the public listed company is a lost cause. Think about it. Is saving dinosaurs likely to succeed? So leave evolution to take its course.

At first sight that seems unthinkable. After all, our economies are structured round the PLC. All our current management thinking is based on it.

But look at it another way. The decline of the listed company just seems to confirm what some of us have come to think anyway: it isn’t just the way executives are paid that is wrong with current management thinking – all of it is. If that is the case, as the companies that behave according to its logic succumb to the inevitable and disappear from the scene, the high-pay problem, and perhaps many others associated with it, will solve themselves. We can then reboot management too. So... the sooner the better. As a matter of urgency we should focus attention instead, as Davis has proposed, on what comes next – new shapes of collaboration and enterprise that are forming under the surface of the economy.

Once the unthinkable has been thought, it’s possible to perceive a number of green shoots poking through. Recent research shows that private US firms invest at twice the rate of public ones, Indirectly supporting the idea that entrepreneurs are preferring to remain private because it is more favourable to the building of long-term value. Although from a tiny base, the number of ‘benefit corporations’, b-corps for short, companies set up explicitly to serve social as well as profitable ends, is everywhere increasing fast. With Ben & Jerry’s as a b-corp cuckoo in his nest, Unilever boss Paul Polman has publicly wondered what it would take for the whole group to follow suit.

Meanwhile, Forbes commentator Steve Denning argues that we are already in a crossover period in which a new economy of vigorous agile young firms unencumbered by past bad habits is growing up alongside the declining dumb old one which it already far surpasses in ambition and soon will also in amplitude and achievement.

Such optimism perhaps comes more easily to Americans than cautious Europeans. Yet while it goes against the grain to ignore the huge injustice of the present position, the charms of beating one's head against a brick wall have long since palled. And remembering Keynes and the remarkable half-life of zombie ideas, it’s as well to take on board the lesson of experience that says it's easier to act your way into a new way of thinking than the reverse. Conclusion, then: it's time to follow the lead of Davis and the US Academy of Management, which at its last two annual meetings has run well-attended discussion sessions on something that may be nearer than we thought: life after the corporation.


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User comments

Andy Lippok :: 13th Jun 15
Well put, Simon. I think the revolution has already started. Look at the level of interest in the Frederic Laloux book "Reinventing Organisations". I'm organising a conference/seminar event at the end of June in Edinburgh at which Jos de Blok the founder of Buurtzorg Nederland will be speaking. Much interest is being shown from around Scotland and in Government in what Jos has to say. So much so that I'm excited about the opportunity of working with Jos and Buurtzorg in setting up a pilot/test of the approach to integrated health and social care here in Scotland. There are different ways of doing work, and as you say Simon, perhaps best we simply leave the dinosaurs of the corporate world to die. The only spot of bother might be where so many of us have our pensions and other investments located in these self-same dinosaurs!
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