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Putting a Lid on Exective Pay

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John Robertson

The Australian government is venturing into some radical new ground in seeking to control executive payments. Even John Howard and Peter Reith in their prime did not dare to apply these labour market principles.

Around the world, there is a backlash against excessive executive payments. In part, this is a justifiable gripe, especially when bonuses are being funded from public money. In part, the complaints are a distraction concocted to help governments weasel out of dealing with the more substantial systemic shortcomings afflicting our financial system. In part, too, politicians are getting their own back because they have long eyed private sector salaries jealously and bridled at the occasional public outrage when their own meagre incomes have been increased.

In moving to put a lid on the size of so-called golden handshakes, Australia's Rudd government has adopted a new principle in setting salaries. The salary of an individual is now going to be tied, under some circumstances, to the success of the employing organization. Executives leaving poorly performing companies, according to ministers, should not be rewarded.

At one level, this makes sense. Relatively successful organizations are contributing more to the national welfare than less successful organizations. The productivity of the former is likely to be higher and, to the extent they set the standards for the rest, the community will be better off. In the extreme, if people avoid poorly performing companies when choosing their employer, the market works to reallocate resources more efficiently.

Such a determinedly market oriented approach to setting incomes, even if only applied initially to a few, is a strange philosophical underpinning for policy from a Prime Minister who has recently decried the excesses of neo liberalism so vehemently and who is part of a labour movement still espousing the merits of income equality across occupations.

Aside from the resource allocation benefits, less well performing companies might also like this system because it could give them a chance to put downward pressure on their costs by having government support their attempts to pay less.

Unfortunately, despite their extensive use of the term, governments do not have a handle on what constitutes good performance. By and large, governments are concerned with catastrophic failures. The corporations laws define when companies fail but do not define what constitutes success or how to judge whether one surviving company is performing better than another.

Governments, as well as a large slice of the broader community, have a preoccupation with financial size. A company making $100 million is usually thought to be more successful than one making $10 million. But what if the first employed capital of $3 billion while the second employed capital of $1 million to achieve these profit outcomes? The concept of a rate of return as a benchmark of success might never have entered the thoughts of some politicians as they speak about corporate performance.

And, among the other considerations in deciding what is an acceptable payment, what about the executives who do an outstanding job in a failing industry? Stemming its losses or preventing a business from failing might have been the task set for them. It would be wrong to treat them as though they were rorting the system if they sought a termination payment in line with executives in what might be popularly regarded as successful businesses.

The government also needs to be careful because markets work. If, for example, executives are told that firm limits are going to apply to golden handshakes, they are likely to demand higher ongoing salaries to compensate. This is especially so if overseas executives are being recruited to join Australian companies. Putting a clamp on termination payments could simply incite a more broadly based salary breakout.

Of course, if governments believe that high salaries are objectionable and that greater income compression should be targeted, they already have the most effective tool at their disposal: a progressive tax system. Set a marginal tax rate of, say, 75% on all annual income of $5 million or more. That should do the job.

This is the route the U.S. Congress is taking but some of the more cautious members of the House of Representatives and Senate are hesitating. What, they ask, will be the community reaction to a tax system used to punish individuals rather than fund beneficial activities in the interests of the broader community? Would that simply invite more widespread hostility and evasion?

Then we get into arguments about incentive effects which is precisely why, through the 1970s and 1980s, high marginal tax rates on the seemingly wealthy in Europe and Australia were reduced.

The government would probably respond to comments such as these by saying that shareholders can make the judgment and approve or disapprove of payments accordingly. That is true enough in the narrow instance for which legislation is foreshadowed. However, in reacting as it has, the government itself is endorsing a range of new standards by which to judge the appropriateness of executive pay.

Is there any doubt, now, that the government believes executives in successful companies can be paid more than those running less successful companies. That might be fine for the CEO but what about his lieutenants? And, what about the middle manager or, ultimately, the worker on the shop floor? If salaries at the top are set according to corporate performance might not everyone get squeezed or, more positively, might they be encouraged to demand more if the corporate performance is superior to that of other companies.

And all of this is happening in a week in which we finally saw the last of WorkChoices, the Howard government's supposedly radical set of labour market policies which had become synonymous with the removal of uniform employment safety nets and the erosion of economy-wide minimum standards of employment.

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