Fat Cat Corruption

It was Peter Drucker who invented the 20 to 1 ratio, suggesting top executives wouldn’t be able to manage their firms effectively if they paid themselves more than 20 times their lowest paid employees, because of the ‘hatred’ and ‘contempt’ in which they would be held. Today, top executives in both public and private sectors pay themselves vastly more than 20 times, simply because they can, authorised by compliant remuneration committees of fellow fat cats.

The phenomenon results from what Bruno Frey referred to as the “crowding out” effects of extrinsic monetary rewards, the intrinsic motivations arising from the satisfaction of doing an interesting and hugely worthwhile job, being “crowded out” by the monetary rewards being pressed upon them or placed within their grasp. (The “socially useless” financial sector is excluded from these considerations – that’s another story!)

Executives in the real economy, and the public sector, may well have started out with intrinsic motivations to leave the world a better place for their brief presence in it. But these higher aims are “crowded out” in what becomes a mindless chase for more money.

But the person inside inevitably judges what others would think if they saw an act of theft, whether it’s picking up a £10 note on the street and pocketing it, or taking a multi-million pound salary. As Adam Smith indicated, it matters what others think; they would prefer others to think well, rather than ill, of them. Only when they know others think irredeemably ill, do they no longer care how their acts impact. Then there is nothing to lose, so they themselves become lost. They surround themselves with sycophants and hangers on, who insulate them from the hatred and contempt of their fellow humans. It’s a pity the sycophants include government ministers and politicans, for example George Osborne and Peter Mandelson notoriously meeting on a fat cat’s yacht a couple of years ago.

2 thoughts on “Fat Cat Corruption”

  1. As the old song goes – who wants to be a millionaire – I do; together with frilly flunkies everywhere and the liveried limousine. There has always been a rags to riches romanticism which has militated against attempts to have a fairer social order. Even under state socialism, the Party flunkies lived considerably better and more privileged lives than the shop floor worker idealised by the ideology. So we need to change the culture from one that idealises riches to one that says that rags to riches is for the fairy tales and ratios of 100:1 and more are unfair and exaggerate the value of those to whom fat cat salaries are paid.

    For example, let’s take the case of Bart Becht CEO of Reckitt Benckiser with his £93 million pay packet last year. As the Times report observed,

    ‘The bumper payout came only days after Richard Lambert, the CBI Director-General, said that executives risked being viewed as aliens from a different galaxy because of their enormous pay.’

    The Times also reported that ‘Frank Chapman had received a £28 million package as BG Group chief executive, while Irene Rosenfeld of Kraft saw her pay rise by 41 per cent to $26.3 million after the Cadbury takeover’.

    Becht’s package consisted of ‘gains on share options granted between 2001 and 2005 as a result of his group’s rising share price. Over the past year he has exercised various share options, worth almost £75 million, and performance-based restricted shares worth £13.1 million’. ‘I’m worth my pay’ he is reported to have said.

    Becht’s basic salary is only ‘just shy of £1 million’. Then he gets a bonus of £3.5 million ‘and other benefits including his pension contribution of nearly £400,000. In total he made £92.92 million last year. He was also granted new share options worth more than £30 million that he will be able to cash in in future years’.

    The company has performed well and reported a rise in sales in 2009 of 18% – pretty impressive in a period of economic recession. Shareholders have seen an increase in total return of 649% during the 2000s.

    Did Becht do all this on his own? Not according to the Times and his company website. Apart from being helped by his Finance Director who earned £1.7 million last year in salary bonuses and pension contributions, and topped this up by making gains on options and performance-related share schemes of about £6 million, he was assisted by the ‘23,000 talented, driven and entrepreneurial individuals, all working together’…. ‘in no fewer than 60 countries’. The website doesn’t tell us what the high to low pay ratio is but it is highly unlikely that his most junior employees start on £50,000 a year, or £4.5 million if you take Becht’s total remuneration.

    What does Becht do with his money? Well he clearly recognises that there is a limit to consumption for everybody, and so he has transferred most of his share options to a charitable trust.

    Why is it necessary to pay Becht so much money even if most of it is equity in the company. I suppose the idea is that if he is successful it is because he is well rewarded and if you reward him well, you will keep him and the company will be even more successful.

    What economics tells us that if you are one of a kind you can command a high rent, that being the difference between what you get and the minimum you would be prepared to do the job for. I am sure Becht would have done the job for less because I assume he enjoys his job and has got a lot of satisfaction from presiding over a successful period of growth for the company. Maybe he has been crowded out by monetary reward and now won’t do the job for less. But whatever the case, is he really worth it? Well that would depend on how far the success of the company can be put down to Becht himself. Did he devise the strategies that led to the company’s success. Did he galvanise the company’s employees to come up with ideas about strategy? Did he select the people who were resposible for the strategy? What exactly did he do and was it really worth so much more than the salary of the employee who makes the sale, or who organises the logistics of distribution or who maintains the IT infrastructure. All employees are important and without each the other cannot function fully or at all. Of course the coordinating function is important and managers across the firm need to be alert and inventive, but so do the other ‘23,000 talented driven and entrepreneurial individuals’. My guess is that Becht gets over 300 times the pay of the lowest paid employee in his organisation, not counting his share options which would bring him to 5400 time the lowest pay. What can justify that difference?

    CEOs are now like entertainers – indeed some become such: John Harvey-Jones and Alan Sugar for instance. Entertainers, whether from music, sport, film, theatre or comedy command similar economic rents. Would Wayne Rooney play premiership football if he was paid £400k a year rather than over £5 million? I suspect he would.

    Cameron has proposed a 20:1 ratio in the public sector which of course Government as employer can impose. But I don’t see any proposals for the private sector. Could not corporate governance rules be reformed to prohibit ratios of more than 20:1 and limit the extent of share options, making them non-encashable for, say, 5 years, with a tax on capital gains if less than 50% of the gains were not put back in the company? Could this be done without international coordination and would that be feasible?

    Definitely time to rein in the fat cats and change the money fuelled culture!

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  2. I agree the time is now. The question is how? Anything that’s too big to fail needs to be broken up. I favour the Glass-Steagall type separation between commercial/retail banking and more speculative activites which are “socially useless”. The latter should be constrained and taxed. There are other specific issues that could be effective. I would reverse the law allowing limited liability partnerships – it sounds like an oxymoron! – that would inhibit the more outrageous hedgting activities. I also like Brown’s proposal to require 2/3 majority votes for take-overs, and for short term shareholdings not to have voting rights, but I would go further giving employees a proportion of equity votes in all M&A decisions. There’s a load of specific regulations that could improve things, but it is the dominant Friedmanite economic philosophy which underlies all these issues which really must be changed. Several other posts on this site have argued the case in more detail so I won’t repeat here. Like all cultural change it will be slow and difficult, but the time now is right.

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