Chief executives win the pay lottery

THE PHRASE “happy as Larry” was coined to describe an Australian boxer who won a bumper prize in the 1890s. But it might have been designed for Larry Culp, the new chief executive of General Electric, who has been awarded a contract that could pay out $237m.

Mr Culp is a member of a lucrative club. In 2017 a chief executive at one of America’s 350 largest firms earned on average $18.9m, according to a study by the Economic Policy Institute, a left-of-centre think-tank in Washington, DC. That is 312 times as much as the average worker, a ratio that is close to its peak in 2000, of 344. The thread connecting those two dates is the soaring value of share options. The stockmarket was at the end of a long boom in 2000 and surged again last year, prompting many bosses to cash in their shares.

Back in 1980, before the enthusiasm for awarding share options to executives took off, the ratio between chief-executive and worker pay was 32. And it turned out that, just as bosses started to be paid more in the form of equity, the stockmarket took off. At the start of 1985 American shares traded on a cyclically adjusted price-earnings ratio (a figure which averages profits over ten years) of ten; now the ratio is over 31, according to Robert Shiller of Yale University.

In Japan bosses have rarely been given share options, perhaps because the country’s stockmarket has never recovered from the bursting of the 1980s bubble. Owing also to an egalitarian mindset, Japanese executive pay is a little more than a tenth of that in America, and about a quarter of the British level.

If the argument goes that executives have to be paid stratospheric salaries to run multinational businesses, this contrast seems odd. Japan has plenty of globally competitive companies in fields such as cars and robotics.

In other words, it is not obvious that CEOs in America and Britain are raking it in because they are uniquely skilled. Moreover, their stock-option paydays have been driven in part by declines in interest rates, designed to boost the whole economy. Bosses have won the monetary lottery.

In a new book*, Deborah Hargreaves, a former journalist (and ex-colleague of Bartleby), describes the experience in Britain. Pay has outstripped improvements in corporate performance. Between 2000 and 2013, the pay of chief executives at FTSE 350 companies in Britain rose by 350%, while pre-tax profits rose by 195% and revenues by 140%.

The standard explanation is that such divergence is the result of a global “war for talent” in which firms must pay up for stars, just as football clubs compete to hire Lionel Messi and Cristiano Ronaldo. But many promote from the inside. Ms Hargreaves cites a 2013 study of Fortune 500 companies, which showed that less than 1% had poached a boss from abroad.

Some reforms have been put in place, particularly the introduction of long-term performance-based incentive plans, designed to discourage chief executives from focusing only on the short term. But these plans have generally been awarded on top of existing pay packages and have done nothing to reduce the huge gap between executive and worker pay.

In Britain shareholders have a “say on pay” in annual meetings and have occasionally staged revolts, such as at WPP, an advertising agency. But last year shareholders at only 18 of the FTSE 100 companies mustered the 20% vote requiring the board to address their concerns under corporate-governance codes. When it comes to companies with billion-dollar valuations, shareholders may not care enough about the impact of high pay in the mere millions.

If investors don’t care all that much, why should others? One problem is that the award of equity to executives means that the income-rich and the capital-rich are more than ever the same people, widening inequality. According to “Global Inequality: A New Approach for the Age of Globalisation”, a book by Branko Milanovic, the likelihood that a person in the top 1% of labour income is also in the top decile of capital income rose from just under 50% in 1980 to 63% in 2010.

Ms Hargreaves argues that a sense of the system being rigged in favour of wealthy elites has reduced public trust in business and fuelled the rise of populism. The Larrys may be happy. The public is anything but.

^{* Are Chief Executives Overpaid?, published by Polity Books}