Thursday, March 19, 2009

There’s Gold In Them Thar Parachutes!

If you have taken the time to read the Prime Minister’s essay on the Global Financial Crisis you probably would not be surprised by the announcement from Wayne Swan that the issue of corporate executive pay and bonuses will be investigated by the Productivity Commission. That inquiry will run for nine months, but ahead of any findings it might make the Treasurer has indicated that the government will move now limit any so called “golden parachute” payments to an amount equal to no more than one year’s base pay unless shareholders vote to allow it.

The rhetoric which has come from both the Treasure and the Prime Minister in recent months has been such that stronger measures would not have been a surprise, but the approach which has been announced is both measured and sensible. Critics might suggest that launching yet another inquiry is simply sideling the issue for another nine months, and that if action needs to be taken the government should simply take it. But it would be wrong for the government to do something as dramatic as regulating executive salaries without any proper examination of the potential impact.

Putting the inquiry into the hands of the Productivity Commission means that an independent assessment will be made on the basis of what is good for productivity and for the nation generally, rather than simply making a knee jerk decision to introduce draconian regulations which could very well prove to be counter-productive. All interested parties will have the opportunity to put their case to the Commission, and if there are persuasive arguments for any particular course of action they will be considered.

In any event I seriously doubt that the Commission will ever come up with a proposal to actively regulate salaries as it would be contrary to the proper workings of a free market. But perhaps it might identify areas where the free market has been distorted by corporate practices which leave the ultimate owners of companies, the shareholders, with virtually no power to control what goes on. Either way, there is another far more appropriate instrument available to government to use to influence activity. Tax.

Actually it is the combination of taxes and subsidies together which provide any government with one of its most powerful tools for influencing all forms of community and corporate behavior. If there is a behavior which the government wishes to encourage it can do so with a subsidy or a tax discount, and if there is any behavior which the government wishes to discourage it can do so with a tax. By far the simplest approach to addressing exorbitant salaries is to penalize them with tax.

This is not a new idea. In fact it is the way things used to be. Decades ago the highest marginal income tax rate was 60%, but only those who were paid around 20 times the average wage fell into that tax bracket. Of course in those days there was no capital gains tax, no fringe benefits tax and so on, so there ways to reward high fliers and avoid the higher rate of tax, but at the same time it did mean that there really wasn’t much point in paying anybody a salary 20000 times the average worker as has happened in the most excessive cases to emerge from Wall Street. It was just too inefficient and wasteful to do so, and as such it constituted a regime which actively discouraged unsound business practices without actually banning them. After all, it could be said that any company stupid enough to pay ridiculous money to executives beyond the worth of their contribution deserves to go broke. But not while the shareholders are denied the opportunity to protect their investment by having some sort of control over remuneration, and not while boards of directors are not held accountable for the limp wristed decisions that they make.

As for the matter of the golden parachutes, it’s all very well to limit the size of such payments to one year’s base pay, but even that remains astoundingly generous in the case of executives who are removed because they have failed. Consider the statutory entitlement to redundancy pay enjoyed by ordinary workers. The starting line is six weeks, a far cry from twelve months. Imagine the screams from executives and shareholders alike if every redundant worker was entitled to twelve months pay! It would be considered to be a calamity of biblical proportions, and the obvious reality that no company could afford such a thing would be shouted by the very people who have enjoyed such privileges themselves.

The reality is that none of these corporate executives are in desperate need. If they have been paid a multi-million dollar salary for a number of years and they don’t have something to fall back on then there is something very wrong. So to place a sensible limitation on the ability of such payments to be made without the approval of the people who actually own the company is only sensible. If any individual has done such a great job that he or she deserves a larger reward there should be no difficulty rounding up the shareholder votes to recognize such an astounding achievement.

I have always said that there is absolutely nothing wrong with rewarding people for a job well done. In fact it is essential that achievement is rewarded or else the whole system falls apart. That’s why it is important that the level of remuneration for any position should reflect both the level of responsibility of that position and the skills and qualifications of the person who holds the position, but the problem has been that the buccaneers have been in a position to essentially set their own salaries and the inevitable outcome has occurred.

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