“Super managers,” governance spotlighted in economist Piketty’s blockbuster capitalism critique
By Henry Engler, Compliance Complete
NEW YORK – May 8, 2014 (Thomson Reuters Accelus) - How much of a role have corporate boards played in rising income inequality in the United States, the UK and elsewhere?
If one reads between the lines of French economist Thomas Piketty’s best-selling blockbuster book on capitalism and inequality – “Capital in the Twenty-First Century” – the answer might be: quite a bit.
The core of Piketty’s thesis and empirical evidence focuses on the long-term relationship between returns on capital and economic growth. Specifically, over long periods of time, when the return on capital exceeds the rate of economic growth, inequality tends to ensue. On the other hand, when growth exceeds capital’s return, income equality tends to improve as wealth is driven more by wage growth. Since 1970, according to Piketty, we have been living in world dominated by the former, with rising returns to holders of capital the primary force behind widening income gaps in the United States and certain European economies. In economic terms “r” – the return on capital – has been greater than “g” – the rate of growth – for some time.
However, Piketty’s examination of the historical goes beyond the “r > g” model. In examining the more recent past, he argues that the rise of a “super manager” class within the corporate sector has essentially paid itself and contributed to a widening of income gaps.
“In all the English-speaking countries,” writes Piketty, “the primary reason for increased income inequality in recent decades is the rise of the super manager in both the financial and non-financial sectors.”
Rise of “super managers”
These individuals — the so-called “super managers” — earn an outsized share of national income. For example, estimates from Piketty’s book, and related research with Emmanuel Saez of the University of California at Berkeley, show that up to 70 percent of the income in the top 0.1 percent goes to these super managers.
So what explains the outsized compensation of this elite group? Piketty argues that “social norms” in the United States and UK have allowed senior managers to set their own pay. “It is only reasonable to assume,” he says, “that people in a position to set their own salaries have a natural incentive to treat themselves generously or at the least to be rather optimistic in gauging their marginal productivity.”
In responding to Piketty’s argument, Robert Solow, a Nobel laureate, notes that the rise of such a managerial class appears to be largely an American phenomenon:
- “It is of course possible that “super managers” really are super managers, and their very high pay merely reflects their very large contributions to corporate profits. It is even possible that their increased dominance since the 1960s has an identifiable cause along that line. This explanation would be harder to maintain if the phenomenon turns out to be uniquely American. It does not occur in France or, on casual observation, in Germany or Japan. Can their top executives lack a certain gene? If so, it would be a fruitful field for transplants.”
Performance-based pay a key factor
Contributing to the increased wealth among such managers, observers point tax code changes in the 1990s that eliminated tax deductions on compensation above $1.0 million that was not linked to performance. As a result, pay-for-performance emerged along with links to shareholder returns, also known as equity-based pay.
According to numerous surveys and research, more than half of chief executive total compensation across many industries is now equity-based and performance related. What is difficult to understand, say analysts, is whether the total compensation indeed reflects performance, even if a lion’s share is equity-based and often dependent on a company’s longer-term financial results.
One of the arguments that Piketty makes is that the rates of compensation for super managers makes little economic sense. The gain in marginal productivity that comes from paying an executive $10 million instead of $1.0 million is negligible, he claims.
Joseph Stiglitz of Columbia University, a Nobel prize winner and author of numerous articles on corporate governance, told Compliance Complete: “There is clearly a disconnect between what executives are doing and how they are getting rewarded.”
“In the financial industry it’s a paragon in a way, not only because of the share of revenues that go to bonuses but also because of the weakness of the link with economic performance,” he added.
Within the financial industry the question of performance and pay has come into sharper focus. Within the last week compensation for 2013 performance came under shareholder attack at Barclays. At a contentious annual meeting last Thursday, more than a third of shareholders refused to back the bank’s remuneration plan, with many arguing the bank should not have increased bonuses during a year when the bank’s profits fell by more than a third.
Separately, the UK Treasury, which owns 80 per cent of the Royal Bank of Scotland, blocked the bank’s proposal to pay bonuses of up to 200 per cent of salary to some staff. In both cases, senior management defended their bonus plans in order to retain talented staff in the bank’s trading businesses.
And outside the financial sector came a revolt at Coca-Cola, with legendary investor and shareholder Warren Buffet abstaining from a vote on the U.S. drinks company’s plan to award shares to employees. Buffet called the proposal, which won approval, “excessive,” and noted this was the first time he had ever abstained on a Coca-Cola vote.
Areas for possible reform
What kind of reform is needed? Regarding executive compensation, Stiglitz of Columbia University points to three areas where greater work and focus is needed:
- Deceptive accounting practices
“Shareholders typically don’t know what’s going on with regard to accounting practices,” he said. Corporate executives and boards, he added, “plead for transparency except where they can make money from it. Deceptive practices prevail across the industry.”
- Uniform tax rates on salary and equity-based pay
“If you tax something at a lower rate you are encouraging those forms of deceptive practices,” he said. “Managers will say lower tax rates are not only a good thing, but we are working even harder and it’s costing you less … A uniform tax on everything would help.”
- Imperfect corporate control mechanisms
Perhaps the most difficult and important area for reform is corporate boards. “There is a general understanding that corporate control mechanisms are imperfect,” said Stiglitz. “When you talk about shareholders, which shareholders? Large shareholders have different interests than smaller ones.” He added that recent reforms such as “Say-on-pay” have worked well where they have been tried, but the makeup of corporate boards remains a problem, with the chief executive retaining broad influence and control over board member election and the timing over such elections.
(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)