In the Money

Right and left, Americans and Europeans, stockmarket investors and anti-globalisation campaigners all share one belief: top managers pay themselves too much. The evidence seems to bear them out. For almost half a century the ratio of top executives' pay to median earnings was as smooth as a boardroom table. Then, starting in America in the 1980s and a few years later elsewhere, this ratio began to increase before taking off exponentially and peaking around the turn of the millennium (see chart). At that point the worker on an American shop floor was earning in a year roughly what his boss on the top floor took home each evening.

Most people think they know what lay behind this. Greedy chief executives, abetted by weak, sycophantic boards, gorged themselves at the expense of savers — more often than not the very pension and mutual-fund investors who, as workers, had seen their salaries and benefit packages fail to grow.

To add to the grievance, many executives did not seem to deserve such rewards. Extraordinary pay for great performance is fine, it is routinely said. But many executives have been paid a fortune for presiding over mediocrity. The Corporate Library, an American corporate-governance consultancy, last year identified 11 large and well known but poorly governed companies, including AT&T, Merck and Time Warner, where the chief executive had been paid at least $15m a year for two successive years even as the company's shares had underperformed. Robert Nardelli received a $210m pay-off when he lost his job earlier this month even though the shares of his company, Home Depot, fell slightly during his six years in charge. Carly Fiorina, ejected from Hewlett-Packard almost $180m better off — including a severance payment of $21.6m — after a lacklustre tenure as chief executive, let it be known in her autobiography that money was not important to her. Not everyone believed her.

Unappreciated
No wonder the standing of executives has fallen so low. A poll for Bloomberg and the Los Angeles Times last year found that 80% of Americans thought executives were overpaid. Even those sympathetic to business are unsympathetic to its leaders. In a second-year class at Harvard Business School quizzed by Ira Kay, head of the compensation practice at Watson Wyatt, a consultancy, two-thirds of the students were critical of bosses' pay. In a survey, Mr Kay discovered that fully 90% of institutional investors — ie, companies' owners — thought executives were "dramatically overpaid". So did 60% of their directors. That is quite a confession, given that directors are the very people who decide how much managers should earn.

But the diatribe against executives is mistaken. Poor governance alone cannot readily explain some of the most striking features of pay over the past few years. To dwell on the undoubted failures of governance is to gloss over the economic and corporate shifts that have been the main causes of the extraordinary rise in top managers' earning power.

National pay schemes vary greatly, and America remains ahead of, and more extreme than, other countries. (That, together with the superior quality of American data and the research they support, is why much of the material in this report is drawn from the United States.) But over the past decade all markets have displayed the same pattern: widening gaps between managers and workers and greater emphasis on long-term incentives. It is hard to see how this could have been caused by universally poor governance across so many different systems.

The chief mistake of the past 15 years was the granting of too many share options to too many people on terms that were too generous. That was costly and unwarranted, but it stemmed more from foolish accounting and tax policies supercharged by bull-market mania than from a sinister plot hatched in the executive suite.

This is not to deny the abuses and downright crookery that have marred executive pay. Even now, dozens of senior managers are under investigation for "backdating" their share options — illegally manipulating the timing of grants to increase the likelihood of a payment. Nor is it to assert that all is right in the boardroom. Indeed, the case for reform is strong.

It is, however, to argue that popular opinion is wrong. The lion's share of the executives' bonanza was deserved — in the sense that shareholders got value for the money they handed over. Those sums on the whole bought and motivated the talent that managed businesses during the recent golden age of productivity growth and profits. Many managers have done extremely well over the past few years; but so, too, have most shareholders.

Between 1993 and 2003 the total pay of the top five executives in the Standard & Poor's 1,500, which accounts for roughly 80% of listed American companies by value, amounted to some $350 billion, according to Lucian Bebchuk and Yaniv Grinstein, of Harvard and Cornell Universities. The share of earnings consumed by those people's pay rose from 5.2% in the first five years of that period to 8.1% in the second five. And this is without counting the value of pensions, which can boost the total by as much as a third.

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