Budgeting for Naked Greed

All sorts of hares are set loose in the run up to the budget: removal of the 50% income tax rate, ending of national pay settlements in the public sector, imposition of a mansion tax, a clamp down on stamp duty avoidance, and so on, not to mention the various stimulus–austerity alternatives. Debate centres around the clash of two different motivations: the desire to get the economy going again, and the desire for fairness and equity, or not. All this punctuated by outbreaks of naked greed by the likes of Bob Diamond. Sometimes those motivations are opposed and sometimes they coincide. Underlying this cacophony, there are simplistic party dogmas, clearly based on half understood or partly remembered ideas from undergraduate economics. Blind faith in ‘free and open markets’ is one such tenet which quite ignores reality: freedom from government interference inevitably results in monopolistic control and predation, a far worse limit on freedom than that imposed by democratically elected government. Check out the audit industry, or the Glencore-Xstrata merger, and have fear.

In amongst all this, Vince Cable, the nearest thing the coalition has to a non-dogmatic, avuncular influence on the economy, is trying to make sure the better off shoulder more of their share of the burden, while those at the bottom of the heap are given some respite, which would also, coincidentally, have some immediate stimulus effect. One Cable initiative is to curb the excesses of executive pay by making it subject to shareholder control. Executive greed is certainly out of control, and on the face of it, restraint by shareholders doesn’t sound unreasonable. But it wouldn’t have the effect Vince intends.

The problem is that the nature of shareholding has changed, and if initiatives are to have their intended consequences, they need to take full account of the new circumstances, rather than being based on old assumptions.

Time was when shareholders invested directly in companies, and a significant proportion of them had a lasting interest in the firms in which they were invested. In those days they might have sought to impose some restraint on executive pay simply because they felt excess was wrong. Or they might have seen it as a form of theft from funds better used for investment in the firm’s future development. Some might even have perceived the ‘hatred and contempt’ it would engender among employees, making effective management much more difficult. Giving such shareholders control of executive pay might have been reasonable and effective.

But today, few shareholdings are owned directly. Around three quarters of money invested in shares is actually invested by intermediary fund managers and traders. And most of the rest is held directly by other corporates rather than individual shareholders. Even pension funds and insurers don’t invest their money directly but go through other financial intermediaries. So not only do the ultimate owners, such as the members of pension funds, not know where their money is invested, these days neither do their pension fund managers. This is important because the intermediaries who nominally hold the shares and control them, are the people who would be enabled to vote on executive pay. But their interests are not the same as the real shareholders. Moreover, around three quarters of all share transactions are today automated so there is no direct human involvement, and none of those holdings would have the capability, on any reasoned basis, for allocating votes on matters such as executive pay. And in those cases where human beings were involved, the interest of traders and fund managers would lead them to encourage further rises in executive pay from which they themselves might indirectly benefit.

There are answers to this. Here are a couple of possibilities that have been floated. Firstly, if shares didn’t carry votes till they had been owned for six months, the vast bulk of financial intermediary holders of shares would be removed from voting. Secondly, shareholdings which have been issued to executives as some form of incentive bonus, as opposed to being bought for cash, could have voting rights suspended until such time as the holder ceases to have any executive role with the firm. This would remove conflicts of interest such as were apparent in the Cadbury disposal, without affecting the incentive effect. These changes would leave longer standing shareholders, who might have some genuine interest in the firm’s long term future, to exercise some restraint on executive pay. That might work, Vince. Pity it’s Osborne’s budget!

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