The Market Rate

The Wall Street Journal was in no doubt. Under the headline "Option Opulence", it reported how the "bull market is bringing huge 'paper' profits to executives" of companies granting options. The New York Times was able to disclose that several inquiries were under way into the "untimely bounteousness" that had created a "new and resplendent class of workers whose emoluments exceeded those of most great owners".

The quaint turn of phrase gives the game away. Those two articles, the first from 1955 and the second from 1933, show that public disquiet — outrage even — about bosses' earnings is as old as the executive dining room.

The most recent great paroxysm in America was in the early 1990s, at the time when Graef Crystal published his book "In Search of Excess". It produced a law that tried to cap the chief executive's salary at $1m, using the tax system. The law caused some bloodletting, but proved a sensational failure: the $1m ceiling in effect became a floor as companies raised their managers' basic pay to the threshold. Christopher Cox, chairman of the Securities and Exchange Commission, last year told the Senate banking committee that the law "deserves pride of place in the museum of unintended consequences".

Just as misgivings about pay seem to crop up in every generation, so they crop up in just about every economy, too. Even Norway, which has one of the world's most compressed pay scales, has introduced laws on disclosure and votes on remuneration (as indeed have most other European countries).

That people everywhere are perpetually irritated by the boss's pay is a good reason to hesitate before drawing conclusions from the latest fuss. It is hard to say, for instance, whether people last year were more annoyed by Lee Raymond, the long-serving head of Exxon Mobil, getting a parting pay packet of some $400m or by the rise in the petrol price to $3 a gallon.

The public debate on pay draws heavily on individual examples. Such anecdotes make an impression partly because they are so dramatic and partly because there is no way of offsetting them by examples of people who have been paid just the right amount.

What the anecdotes show is that chief executives sometimes abuse their position and that boards sometimes pay them too much. That may be wrong, but it is not surprising. After all, the shift from imperial chief executive to options-rich manager is founded on the idea that companies are run not by philosopher-kings pursuing the common good but by people made of flesh and blood and with a keen sense of self-interest. Similarly, pay packages are complex contracts that may be drawn up in one set of economic circumstances and enacted in another. Any market will produce examples of people who overpay at the peak of a boom, say, and live to regret it when the bubble has burst. The question is what all these particular stories reveal about governance in general, and about its part in explaining the rapid increase in executive pay.

Wrong Time, Wrong Place
The main weakness of the governance explanation of excessive pay is that the conduct of boards and the market for chief executives have both been improving in recent years. Pay took off at a time when executives were under more scrutiny than in the 1950s and 1960s, a period of restraint in spite of a bull market for equities. It is hard to explain by weak governance why powerful executives back then should have passed up the chance for higher pay that their less powerful successors were later able to seize with both hands. Similarly, flaws in the system of hiring executives can explain rapidly increasing pay only if the market had failed sensationally in the 1980s and 1990s. Instead, the market for executives has grown steadily. Certainly it is imperfect, but it is less imperfect than it used to be.

The pattern of pay over the past few years is also hard to explain in terms of governance. Thanks to new listing rules adopted by the New York Stock Exchange in 2003, chief executives are no longer on the nomination committee for directors, they cannot receive loans from directors, directors are more independent, and pay consultants work directly for the compensation committee rather than reporting to managers. Moreover, after the controversy over pay and the scandals following the collapse of the internet bubble, boards can be in no doubt that the chief executive's pay will now be subjected to minute scrutiny.

David Nadler of Mercer Delta, a change consultancy, describes all this as a fundamental change in the authority of the board. "For 20 years you didn't need to know about the board," he says. In the bad old days board members used to fall asleep and drink too much. When people were unprepared for board meetings, everyone would laugh, "give 'em lunch and send 'em home." These days boards are monitoring their own performance and seeking advice on how to cope with splits and conflict. Boards must routinely meet in "executive session", that is, without the chief executive present. That encourages directors to talk frankly and raise questions without seeming to confront managers or undermine their authority. Executives "used to talk about 'my board' in the imperial sense", Mr Nadler says. "Now managers are employed by the board."

• 1
• 2
• 3
• next »