The US House of Representatives recently
passed a bill to strengthen shareholder oversight of top executive
pay. More than 50 Republicans joined the majority. The law’s prospects
in the Senate (where a similar bill was immediately introduced by
Barack Obama) are uncertain, but that Republican backing in the House
was telling in itself. The narrow issue of top executive pay, tucked
inside the broader issue of rising inequality of incomes, appears to
be gaining some unaccustomed political traction.
As a rule the US takes a tolerant view of inequality. What counts, most Americans believe, is opportunity and merit. There must always be plenty of the first and then, if you have the second, you reap fabulous rewards.
Consider a small but revealing instance. When the press got hold of John Edwards’s $400 haircuts – and remember that Mr Edwards, more than any other candidate for the Democratic presidential nomination, offers himself as a champion of the poor – it was no more than a minor embarrassment. Challenged about it in the first of the Democrats’ televised debates, the gorgeously coiffed Mr Edwards apologised and then said: “If the question is ... whether I lead a privileged and blessed lifestyle now, the answer to that’s yes ... The reason I’m running for president of the United States is so that everybody in this country can have the same kind of chances I’ve had.”
There you have it: everybody deserves a $400 haircut, or at least a fair shot at that dream. The nation nodded and said: “Absolutely.”
This regard for ambition and success, and the relaxed view of inequality that goes with it, is not without drawbacks for those at the bottom. On the other hand, it has much to do with America’s remarkable economic vitality. It takes a lot to disturb this composure. Lately, though, it has been disturbed, and the reason is the perception that the rules are being broken.
Incomes at the very top are rising extraordinarily fast, at a time when middle incomes are barely keeping pace with the cost of living. In addition, taxes on top incomes have been cut much more sharply than taxes lower down. Worst of all, corporate scandals, option-pricing irregularities and enormous pay for calamitous performance point to outright reneging on the meritocratic contract. “Pay for failure” seems especially resented – hence the proposed law to give shareholders an “advisory” vote on top executive pay.
Has America’s rewards-for-merit contract broken down, as the law’s supporters argue? Are top executives looting the companies they work for? The prosecution has some persuasive facts and some compelling tales of excess to relate, but the case is by no means, to coin a phrase, a slam dunk.
The leading academic spokesman for the view that the system is broken is Lucian Bebchuk of Harvard Law School. Mr Bebchuk testified in support of the proposed “say on pay” law to a House committee in March. He argues that patterns of top pay reflect an abuse of managerial power – in effect, that pay is not negotiated at arm’s length, but among insiders, with much mutual back-scratching and boards failing in their duty to shareholders. On the face of it, the analysis is right. Practices such as disguised compensation and generous uncontracted “goodbye payments” to failed executives are difficult to explain in any other way.
However, the sense that something has gone wrong system-wide, not merely in particular egregious cases, rests on the surge in aggregate top pay, and especially on the widening gap between what managers receive and what they pay workers. Here the economics needs careful handling.
If top managerial talent is finely differentiated, and if boards are able to distinguish excellent chief executives from less-than-excellent ones, the best managers will end up running the biggest companies and market forces will link their pay to the value of the assets they control. It turns out that top executives’ pay in America has been rising roughly in line with the market capitalisation of the companies they run. That is an anomaly calling for an abuse-of-power explanation only if you think that the CEOs of big companies are as readily interchangeable as their middle managers, factory foremen and clerks. Plainly they are not.
Specific abuses are still abuses and ought to be remedied where possible. The broader problem of top pay, framed as a market failure, may nonetheless be smaller than it looks. Political sentiment cares little for such distinctions, however. The sheer pace of increase in top pay, combined with undeniably outrageous instances of managerial gouging – all with Enron, WorldCom, Tyco and the rest fresh in the memory – is proving enough to shift the country’s mood.
Even if only at the margin, this will have an effect on next year’s elections, helping the Democrats and hurting the Republicans. It will give a gentle extra push to a variety of policies – higher taxes on the rich, new social obligations on companies, foot-dragging on trade liberalisation – that draw strength from an anti-capitalist humour. On substance, the “say on pay” law will make little difference, and the issue it is addressing may be at least partly illusory. But it would do no harm, could actually improve corporate governance here and there, and may lessen the country’s developing appetite for anti-business initiatives. That makes it a good idea.
clive.crook@gmail.com
As a rule the US takes a tolerant view of inequality. What counts, most Americans believe, is opportunity and merit. There must always be plenty of the first and then, if you have the second, you reap fabulous rewards.
Consider a small but revealing instance. When the press got hold of John Edwards’s $400 haircuts – and remember that Mr Edwards, more than any other candidate for the Democratic presidential nomination, offers himself as a champion of the poor – it was no more than a minor embarrassment. Challenged about it in the first of the Democrats’ televised debates, the gorgeously coiffed Mr Edwards apologised and then said: “If the question is ... whether I lead a privileged and blessed lifestyle now, the answer to that’s yes ... The reason I’m running for president of the United States is so that everybody in this country can have the same kind of chances I’ve had.”
There you have it: everybody deserves a $400 haircut, or at least a fair shot at that dream. The nation nodded and said: “Absolutely.”
This regard for ambition and success, and the relaxed view of inequality that goes with it, is not without drawbacks for those at the bottom. On the other hand, it has much to do with America’s remarkable economic vitality. It takes a lot to disturb this composure. Lately, though, it has been disturbed, and the reason is the perception that the rules are being broken.
Incomes at the very top are rising extraordinarily fast, at a time when middle incomes are barely keeping pace with the cost of living. In addition, taxes on top incomes have been cut much more sharply than taxes lower down. Worst of all, corporate scandals, option-pricing irregularities and enormous pay for calamitous performance point to outright reneging on the meritocratic contract. “Pay for failure” seems especially resented – hence the proposed law to give shareholders an “advisory” vote on top executive pay.
Has America’s rewards-for-merit contract broken down, as the law’s supporters argue? Are top executives looting the companies they work for? The prosecution has some persuasive facts and some compelling tales of excess to relate, but the case is by no means, to coin a phrase, a slam dunk.
The leading academic spokesman for the view that the system is broken is Lucian Bebchuk of Harvard Law School. Mr Bebchuk testified in support of the proposed “say on pay” law to a House committee in March. He argues that patterns of top pay reflect an abuse of managerial power – in effect, that pay is not negotiated at arm’s length, but among insiders, with much mutual back-scratching and boards failing in their duty to shareholders. On the face of it, the analysis is right. Practices such as disguised compensation and generous uncontracted “goodbye payments” to failed executives are difficult to explain in any other way.
However, the sense that something has gone wrong system-wide, not merely in particular egregious cases, rests on the surge in aggregate top pay, and especially on the widening gap between what managers receive and what they pay workers. Here the economics needs careful handling.
If top managerial talent is finely differentiated, and if boards are able to distinguish excellent chief executives from less-than-excellent ones, the best managers will end up running the biggest companies and market forces will link their pay to the value of the assets they control. It turns out that top executives’ pay in America has been rising roughly in line with the market capitalisation of the companies they run. That is an anomaly calling for an abuse-of-power explanation only if you think that the CEOs of big companies are as readily interchangeable as their middle managers, factory foremen and clerks. Plainly they are not.
Specific abuses are still abuses and ought to be remedied where possible. The broader problem of top pay, framed as a market failure, may nonetheless be smaller than it looks. Political sentiment cares little for such distinctions, however. The sheer pace of increase in top pay, combined with undeniably outrageous instances of managerial gouging – all with Enron, WorldCom, Tyco and the rest fresh in the memory – is proving enough to shift the country’s mood.
Even if only at the margin, this will have an effect on next year’s elections, helping the Democrats and hurting the Republicans. It will give a gentle extra push to a variety of policies – higher taxes on the rich, new social obligations on companies, foot-dragging on trade liberalisation – that draw strength from an anti-capitalist humour. On substance, the “say on pay” law will make little difference, and the issue it is addressing may be at least partly illusory. But it would do no harm, could actually improve corporate governance here and there, and may lessen the country’s developing appetite for anti-business initiatives. That makes it a good idea.
clive.crook@gmail.com