Tuesday, May 23, 2006

Unrepresentative swill (Part 3)

Having had a go at the undemocratic way the Australian democracy works (see Parts 1 and 2 under the Opus d'Guambat sidebar >>> that way), Guambat has been moved to have a word or two about corporate democracy after reading an article in the business sheets of the Sydney Morning Herald, today.

There have been many scholarly studies and reports about corporate governance, and this post is not one of them. This is just another rant. And the article that sparked this wasn't about corporate democracy, per se, but was more precisely about executive pay.

Now executive pay abuse is not a subject to dismiss out of hand. Even the Captain America Larry Kudlow has pronounced some of the recent examples of executive pay as outrageous and, in the case of the re-dated options scams, fraud. USA Today offers some assistance in how to locate the details of "obscene" executive pay in this column.

The San Jose Mercury News is running a similar line with its story, Shining a light on executive pay (free reg required) and has a related report that tells us, "The average direct compensation received by the 749 top Silicon Valley executives in this year's survey was 51 times larger than the average pay made by Silicon Valley workers in 2005, up from 44 times larger in 2004."

That's pretty modest. Guambat previously mentioned a CNN/Money report that said the average CEO pay was 451 times the amount of the average production worker in 2004.

The instigating article for this post continues with that meme:
New studies in Australia and the United States show the aristocrats and capitalists of the industrial age have been supplanted by the working rich, particularly the superstar chief executive officer.

"At the start of the 21st century, the income share of the richest 1 per cent of Australians was higher than it had been at any point since 1951," say economists Sir Anthony Atkinson, of Oxford University, and Professor Andrew Leigh, of the Australian National University, in the first detailed study of incomes of Australia's super rich.

"Much of this recent increase may have been caused by higher executive pay."

The ANU paper, The Distribution of Top Incomes in Australia, shows not all elite professionals have shared in these fabulous returns.

High Court judges have plunged from a multiple of 17 times average earnings in 1921 to just six times in 1988, before rising to almost eight times.

In that time, according to tax return data, top federal public servants had their relative wages cut from 10 times average earnings to less than five.

And politicians, whatever you might think of them, have seen their wages fall from 5.6 times average earnings in 1921 to 2.3 in 1988, before they rose slightly to 2.7 times average earnings in 2002.

Reliable historical data is not available for chief executives. But in the decade to 2002, Sir Anthony and Professor Leigh say CEO salaries of the top 50 companies rocketed from 27 times average earnings to 98 times. And they have escalated since.

Similarly, a study this year by John Shields, of the University of Sydney's School of Business, showed the 51 listed companies whose CEOs are members of the Business Council of Australia had given their chiefs a 564 per cent pay rise since 1989-90.
But it was not so much the scale of the executive pay that struck me, especially since Guambat has been noting that issue since he first started his Stew. It is rather the conclusions drawn by the authors of the study mentioned in the Herald story that irritated.

"[T]op Australian executive salaries have closely tracked US salaries, albeit from a lower level." This is an irritation that Guambat spoke of before. Australian managers have long whinged that their salaries were unfairly inferior to US executive packages. Ross Gittins, the Herald Economics writer, referred to the use of this old chestnut by Michael Chaney, president of the chief executives' union (otherwise known as the Business Council of Australia). In his review of that article, Guambat noted:
It's too bad Ross missed that little slight of hand that Michael Chaney tried to pull, comparing Australian executive remuneration to the "much higher paid" US executives as more evidence they are underpaid here. That's exactly the opposite of what they do when they talk about regular employees. In that case they bleat and piss on about how that same job could be had for one-tenth the cost in some foreign country like China or India.

How do they have the gall to compare their wages to higher paying countries while comparing the wages of the lower rung employees to the lower paying countries? (Don't bother; that's rhetorical.)
The Herald report of the current study we're discussing goes on:
In the United States, income inequality has widened at the bottom of the income scale as well as the top.

A study this year by Ian Dew-Becker and Robert Gordon for the National Bureau of Economic Research showed that fully one half of all America's productivity gains since 1966 had found their way into the salary packets of the top 10 per cent of earners.

The other 50 per cent of productivity gains filtered down to the bottom 90 per cent, where real wages fell.

Australian inequality is widening only at the top. Low earners have been protected by generous family welfare payments and wage-setting structures. [Which taxpayers, not companies, underwrite.]
The way executive have managed to skim all the productivity gains squeezed from the production workers has also been noted previously by Guambat:
"Normally, as employees are able to produce more in each hour of work, the result is greater cash flow that can be divvied up between workers and owners or investors. In the long run, rising productivity means rising wages and living standards.

The latest numbers from the Labor Department, in fact, show average weekly earnings for US workers have fallen by 0.5 percent in the past year, after adjusting for inflation."
And while workers lost out on productivity gains, the executives have been mopping up on so-called performance gains, as Dr Sheilds' study reported in the Herald explains:
Executives also point to the performance-based nature of their salaries, arguing that their salaries ensure executive and shareholder interests are aligned.

Moss, for example, earned a base salary of $670,604 - and then claimed the residual $20,506,183.80 as various performance payments.

Macquarie Bank's performance fees are more transparent that most. But academics are increasingly questioning the sort of performance that many companies are rewarding.

A University of Chicago study tracked CEO salaries at 50 American oil companies, where extraneous "luck" relating to changing higher oil prices could easily be distinguished from management performance.

The authors, Marianne Bertrand and Sendhil Mullainathan, found CEOs were paid handsomely for oil price changes in the 12 years of their study that prices rose.

"Chief executive pay in fact responds as much to a lucky dollar as to a general dollar," they said.

CEO pay also rose, however, in the five years when oil prices fell.

"This hints at an asymmetry: while CEOs are always rewarded for good luck, they may not always be punished for bad luck."
Your Guambat has also had a run at this performance argument in another prior post:
Now this is where we need to start paying attention, because this performance thing is pretty tricky in this circumstance. You will have heard the old saw that a rising tide lifts all boats? That's what we have to watch for. Think back to the chart posted earlier today, showing the whole Aussie market has been rising. If a company's value rises because the whole market, or a particular segment of it, is rising, does that represent "performance"? Do you reckon the guys on the lower rungs get that increase lauded in their performance reports?

In addition to the coincidental rising values, there is a similar boat lifting exercise that moves executive and board pay in a lock-step fashion. Think of the locks in overland canals that manage the flow of water to carry boats up hill. Think back to this quote: "compares favourably with the fee pools of Australian companies of comparable size".

Now, I'm one who does believe that a good executive is due a good wage. I don't begrudge a well paid exec her due. But I think boards should be as disciplined in setting executive pay as the executives are in setting lower rung pay, and that all employees should share, if any do, in the rising and falling tides. Because, really, it is the shareholders who should get the greatest benefit of rising tides, as they take the greatest hit on falling tides, such tidal flows being what market risk taking is all about.
And it is about here in the Herald story that the authors of the story get a bit down and dirty. They pass right over any pretence of whether such payment scheme is fair or reasonable, and simply ask, "how do these guys (they're mostly guys), get away with it?" And then they propose an answer:
The authors present an alternative explanation for spiralling executive salaries: CEOs are uniquely placed to "capture" - or rig - their own pay-setting processes.

In this view, executives unduly influence their own boards and are constrained only by what their shareholders will let them get away with. If their salaries rise fastest when profits rise, it is because shareholders are more likely to turn a blind eye when they themselves are making money.

Dr Shields believes executive salaries have made a "major' contribution to widening income inequality at the top - and much of this is due to inefficient, if not ethically dubious, executive behaviour. "I don't accept the argument that says the pool of CEO talent is so minuscule that companies have to pay almost anything to get these rare human beings," he says.

Dr Shields says chief executives have inverted the lawful management structure whereby directors are engaged to control them.

"I tend to think of CEOs as behaving in the same way as traditional craft unionists: defining their own levels of skill, setting market rates for that skill, engaging in market closure and bargaining for premium levels of pay," he says.

Dr Shields says massive golden handshakes, post-retirement consulting fees and performance options that, bizarrely, can be hedged against risk, are other examples of executive " wealth by stealth".
And often it seems the wealth comes as much by filth as stealth, as seen in the current scandal du jour surrounding the re-dating of executive stock options, this from the Akron Ohio Beacon Journal, not one of the heavyweight business journals:
Given the growing number of companies involved, it's starting to look like backdating stock option grants to boost executive pay was another one of those dirty little secrets where no one thought to trust their common sense.

Even if this practice wasn't illegal, it should have produced different accounting under the rules that governed employee options until recently. Yet there was a leap among top executives, the corporate directors who oversee pay, and the accountants, lawyers and consultants who advise them.

Otherwise, it's hard to explain why UnitedHealth Group Inc. and others embroiled in this expanding scandal would be acknowledging that past profit reports may have been inflated.

By artificially boosting profits, backdating may have fueled larger bonuses for executives. Likewise, giving instant value to grants that normally would have zero starting value cancels at least part of the presumed incentive options given to executives.

Formally speaking, this practice is not widespread, said compensation experts at Mercer Human Resources Consulting and myStockOptions.com.

But once one company allows a perk, others say ``Me too.'' That attitude also may have affected the accounting for what otherwise would seem a straightforward exercise.
So here we are. The managers of these public companies are able to reward themselves pretty much as and when they please. And why is that? To repeat Dr Shields' conjecture, it is because the management has "captured" the remuneration process and has "inverted the lawful management structure" by subordinating the power and duty of the boards.

Which brings us to the notion of corporate democracy. Democracy is the idea that if you have a stake in something (e.g., if you are a citizen of a country you might believe you have a stake in it), your view of major decisions regarding or affecting your relationship with your stake ought to be given some notice and you should have some opportunity to shape that decision.

In popular public governance we have the notion of "one person, one vote"; in corporate governance terms it is "one dollar, one vote". But in each case each unit does have a vote, that is to say, an opportunity to shape the outcome of the vote. Mind you, this is more conceptual than practical.

The basic structure of corporate governance was established just a few hundred years ago and fine-tuned over the last hundred years. Corporations didn't use to exist. A business was owned by and the responsibility of individuals. As the mecantile world got a bit more wide flung across the seas and dependent on the judgment of persons not in the control of the owners, merchants sought a legal structure that would secure their profits from these outposts of trade but without the responsibility associated with bad judgments that they could not control. They sought to keep their profits but avoid their liabilities.

The landed gentry thought this idea a bit rich. They came from feudal roots of personal responsibility. But they were practical, too, and saw a precedent for just this sort of thing in the ancient relationship of trust, where the trustee, duly exercising the powers and obligations of trust, would not be personally liable for things that went bump in the night. And so they created this new legal creature called a company or corporation that extended to its investors the veil of no personal liability for company debts, but only so long as the company was directed and run in such a fashion that the business exist for the trust and benefit of its owners.

This notion of duty (to the investors) and trust (in the judgments of the management) is at the foundation of modern corporate structure, governance theory and practice, at least ideally. And it is the feedback principle that passes as corporate democracy that allows, requires, the investors to communicate their interests to the managers and directors, because without communication the scope of these requirements would be difficult to ascertain and enforce.

Just as this simple model works easiest when the numbers involved are smaller, the more people involved, the more complex the whole thing gets, from every perspective, legal, social and economical.

But this wasn't a great issue of modern life until the last few decades. At the beginning of the 20th century, only a handful of the public owned any corporate stake (shares). It wasn't until after WWII that having a piece of the corporate rock became anything that the average person would even aspire to.

I reckon that public ownership of corporations didn't really kick off until mutual funds were popularised from the 1970's, and then when the Republicans invented the "ownership" society and privatised pensions and social security, they whole character of the subject changed and the issue became common parlance in the home, the taxi, the beauty parlour. Now, most folks who have something to say or think about corporate governance have their money where their mouths are; it is no longer just an academic diversion.

And I don't have any prescriptive ideas about where to go with all of this. Mankind has always had to organise around wealth production, common defense and the pursuit of prosperity within a cohesive social whole. The methods tried have ranged from the despotic to the utopian, so we do have some experiences to draw knowledge from. And I suspect we will evolve with this corporate paradigm, too.

But as we do evolve this thing, we need to remember its roots and purposes and contexts. We need to be aware of the disenfranchisement of the stakeholders. These days, though the numbers of stockholders has increased like wild fire, the direct ownership has been more and more marginalised through involvement in funds of funds of friends of funds. There is a firewall now between the owners and the management that precludes the feedback mechanism that I consider to be essential for the construct to remain a credible means of organisation. You can only disenfranchise people for so long before they bring the house down.

And there is a greater context, also, over the last few decades. The global companies now more frequently conflict with the interests of states in which they exploit their skills and interests, and so often, it is an unfair match, with the size of the company dwarfing the size of the state.

If the sovereignty of the state is going to be usurped by the power of the corporation, we really do need to think about ways of putting good old fashioned public democracy into the corporate demeocracy model.

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