Monday, March 2, 2009

Rewarding Failure Is The Real Obscenity

The genuine concern over excessively generous corporate executive pay packets and bonuses could easily be overshadowed by some of the more hysterical suggestions for cutting the tall poppies down to size. While the federal government is openly canvassing ideas on how to deal with what is a legitimate problem, there is the temptation to simply label all big pay packets as obscene. Unfortunately such a label only obscures the real problem while doing nothing to solve it.

We frequently hear criticisms of “obscene” figures, but the truth is that there is no such thing as an obscene amount of money. It is just an amount, neither good nor bad, nothing more nor less. What may or may not be obscene is what is done with that amount. If it is paid as a reward for destroying value, cutting jobs, and delivering an inferior result, then that could well be obscene. But more likely it is simply an example of bad judgment and poor business practices, inspired by self interest and greed in people who are not held sufficiently accountable.

At the same time the idea that all big pay packets are bad is equally counterproductive and equally stupid. Salary payments in any kind of sensible world should reflect the level of responsibility of a position as well as the qualifications and the skill of the person in that position. There is nothing wrong with using incentives and bonuses to reward achievement. In fact, it’s important for people at every level to see real rewards for their efforts, and if your efforts are at the highest level it makes sense that the rewards should also be higher.

But that is the problem with the current state of play. Corporate pay structures have been rewarding the wrong things, with extreme cases seeing failed executives being paid big fat termination payments to go away and stop causing trouble. It is fundamentally bad business practice to reward failure and to pay sums that don’t represent value in terms of the performance of the executive. The corporate buccaneers who have been lining their own pockets have gotten away with it because those who should have been responsible, that is the directors, have fallen for false arguments about paying top dollar to get top people, who ultimately turn out to be working for their own interests rather than the interests of their shareholders.

That’s why there have been increasing calls for some kind of government regulation to cap salaries. While it sounds appealing to the workers who have been put out of a job, and to consumers tired of being ripped off by companies selling inferior products at premium prices, a salary cap is actually not a good idea. It is contrary to the principles of a free market, and would be counter productive in that it would act to remove incentive. For business to succeed there must be the capacity to reward those who make that success happen. Of course, that capacity should extend to everybody in the company, not just a handful of managers at the top. It is conceivable that top managers may well be worth many millions of dollars, and if the company is sound there should be no impediment to any reasonable reward.

Of course, just because something is a poor business practice doesn’t stop it from happening, so there is a need for some form of regulation. The purpose of regulation should be to protect human rights, to prevent abuses of power, to encourage best business practices, and to prevent criminal behavior. Regulation should discourage excessive rewards from being given for the wrong reasons, and the usual tool for any government to discourage anything is tax. Any review of regulations for corporate salaries should revisit the old practice of imposing a high marginal tax rate on supersized salaries. Once upon a time, the top marginal tax rate was 60%, levied on those who earned about 20 times the average wage. Today, that would be around $1.2 million, right in the ballpark for this debate. Along with that there is also a clear need for increased power for shareholders in approving or blocking bonus payments, rights and options issues, and all of the other methods of handing over shareholder equity as a substitute for actual cash.

Those two measures should help restore some commonsense to corporate management without the need for communist policies like government regulated salary caps.

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