Executives’ salaries – should they be capped?

My employer, a stock-listed financial institution has recently published its annual report. Shareholders have a reason to be cheerful – despite tough macroeconomic conditions, shrinking revenues and assets base, the institution fetched a much higher net profit (thanks to successful downsizing, which if continued, may any day wipe out my position) than in 2011, but in the meantime earnings of management board members dropped by on average 20%. This is kind of peculiar, as we have already got used to ever-rising salaries and bonuses of fat cats…

Even if we have got used, it means we (as society) tolerate it as best, as we cannot change it. Cannot? The example of Switzerland, where 68% of voters supported in a referendum an initiative of capping salaries, bonuses and severance packages of top executives of stock-listed companies gives lie to such assertion. The news from Switzerland are staggering mostly because this country is perceived as home of liberal capitalism… Someone had enough power and determination to draw a line…

But even if you are a free-market advocate…Start over… Especially if you are a free-market advocate, should not you come to think something is amiss if one person earn a significant fraction of the whole big corporation’s yearly pre-tax income? In Poland people are outraged if a CEO of a big company or a bank earns 2 million zloty per year. In Switzerland amounts which evoked outrage are twenty times higher… Why so much? Is work of one man really so valuable for a company?

My first guess is that level of executives’ remuneration is a matter of ‘rotten consensus’, saying those ‘top dogs’ simply have to earn zillions, which in turn influences market valuation of top positions – if all companies pay an outstanding (indeed?) manager 2 million per year, if another company decides to pay only 1 million, no outstanding manager would be eager to work there… Such mechanism, probably in practice, keeps salaries of top executives sky-high. Free market would not solve this problem, as all companies would have to concertedly cut salaries of their managers so that the new equilibrium of this narrow spot of labour market is set. If free market is helpless, citizens of Switzerland decided the government, as lawmaker, should get to grips with this pathology…

But actually why do we care? The first cries of outrage at flawed remuneration schemes were heard in first quarter of 2009, when bankers from bailed-out financial behemoths granted themselves bonuses, as if performance of their institutions had been exemplary. The key justification for bringing unruly bankers to the heel was the support they were receiving from taxpayers’ purses. OK, how about the current situation then, when taxpayers do not contribute to sky-high pays? If an executive’s remuneration is excessive, it may hit: other employees, who earn disproportionately less than the executive, the company’s clients, who indirectly bear costs of management and, at most, the company’s shareholders – salaries are expenses which bring down profit before tax, and consequently their income. This is why the Swiss law should cover only stock-listed companies – it is aimed at protecting shareholder’s value from being depleted by fat cats.

Going back to rationales why executives are so highly-paid – some argue it is by dint of the responsibility they take. They sign hundreds of documents, work out and approve strategies of companies they run. Without them a company could practically work, but due to formal limitations, it cannot, without their approvals it would cease to operate normally very quickly. But at the end of the day, this argument can be disproved easily – in the worst case if they make wrong decisions, they may be fired and nothing else bad happens to them – do they take responsibility with their own money for flawed decisions? No! Firstly because with such provision nobody would like to take up such job, secondly, because they acted in the best interest of the company, they cannot be called to account and they retain the right to claim a generous severance package…

When almost a year ago my company announced it would lay off 10% of its staff, the CEO organised a chat with all employees. One of them dared to ask whether the CEO thought it was OK to cash in a very big salary and fire hundred of people. The answer was nobody should be outraged at it, as if it was not him, someone else would earn that money. Rising to the position of CEO of a big company is only a matter of combination of luck, skill and hard work. So the door is open, but why so can climb to the top of their ladder? Incidentally my colleagues and I condensed his purport into one sentence: “any (moron) can become a CEO”. This means it is not a specific person, who, on account of their unique combination of skills, knowledge and experience, earns zillions, it is a CEO, who on account of holding such position, earns millions. The foregone conclusion is then that remunerations of top executives are loosely tied to value they add to companies.

Scale of scandals concerning disproportionate bonuses in Poland is much lower than in Western Europe. The most recent object of public outrage are executives of PL 2012 – the company which co-ordinated preparations for and execution of last year’s football championship in Poland. The event was not a complete disaster, so both guys received over a million-zloty high bonuses. Without going into details, the fact they were rewarded so generously was in the opinion of many immoral, but indisputably not illegal. Here is the case. If parties of a contract voluntary agree for a specific terms and conditions of employment and remuneration, should anyone be allowed to interfere? In the public sector indeed, as at the end taxpayers funds these bonuses, and even if it is private sector, there is a possibility of accusing the one who signed such contract with remuneration not tied to performance of mismanagement. The very act of accusation is simple, but path to proving this and holding somebody accountable is long, windy and full of potholes just like Polish roads after winter.

If we touch upon legal aspects, it is not purely about law, it is about circumventing it. And when big money is at stake, some money is worth being sacrificed to save or earn much more money. Managerial contracts, which are a form of self-employment in Poland are a way of circumventing the salary cap law which sets upper limits of remunerations in public sector. They have one more advantage – they allow to pay a flat 19% corporate income tax instead of falling into second, 32% bracket of personal income tax…

Do not worry about the rich, they are sly, powerful and resourceful enough to foster their interests. They will always hire lobbyists to protect themselves and lawmakers will always find it hard to put up resistance to powerful lobbies. Therefore I see a long way ahead before proponents of pay cap law in Switzerland. The lobby of executives will point out it will have negative impact on quality of management and will scare everyone with visions of the world falling apart without high-paid executives. The only plausible aftermath is that the new law will surely have loopholes and someone would benefit from advising how to circumvent it…