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The Revolution in Salaries

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

The anger whipped up over AIG and corporate bonuses risks putting far more emphasis on the bottom line and less on corporate social and environmental impacts.

One of the consequences of the global credit crisis has been an unprecedented focus on executive salaries. Particularly when government funding has been used to secure corporate viability, public outrage has been extraordinarily swift and brutal. The bonuses paid to AIG executives hit an especially sensitive public nerve.

The anger has not always been directed against corporate wrongdoing. Given the scale of the economic devastation caused by bank failures, there are extraordinarily few accusations of criminal conduct.

This is very different to the corporate failures of 2000-01 such as Enron which were due to financial shenanigans culminating in criminal charges or the collapse of the 200 year old Baring Brothers merchant bank in 1995 due to unauthorized trading activities which also resulted in time in jail for the perpetrator and the demise of the firm.

Large trading losses have certainly been incurred but not through dishonesty. They have happened largely for the reasons they always happen: people simply failed to understand fully the macroeconomic environment in which they were trading as they kept betting on the most recent conditions persisting indefinitely.

US Congressional hearings, going down the same track and not having uncovered any significant wrongdoing, have converged on a culprit and a new remuneration principle: executives should be paid according to the success of the organizations for which they were responsible. If you run a failing company, expect public scrutiny and a pay cut.

This begs the question of what constitutes corporate success. There is nothing in western country corporate laws to define success. Those laws typically define catastrophic failure (i.e. bankruptcy) and its consequences but never success and there are no legislative criteria to clarify whether one company is more successful than another.

At one level, paying people in line with their financial contribution seems justifiable enough. Post a loss and you are shown the door. Make a profit and be rewarded. Basic economics advocates something similar. It suggests paying everyone according to their marginal product (i.e. in accordance with what each contributes).

Economists also argue that economic growth is slowed and welfare damaged if companies are forced to pay workers without regard to the financial viability of the businesses employing them. Hence economists almost always criticize centralized tribunals fixing nationwide wages. Some even oppose national minimum wages as damaging employment growth.

However, paying according to corporate well being is a radical departure from the widely adopted principle of equal pay for equal work. That goes down the drain. So does the notion of a living wage if a company's financial position dictates what someone should be paid and not the person's needs.

The commercial incentive to extend these principles beyond only the most senior executives will simply be too great. The new criteria will spread well past the executive floor once there are no longer philosophical or legislative barriers to clear.

We are already seeing workers at all levels being asked to take pay cuts to match the abilities of companies to pay in a recession. Those workers luckily employed by more profitable enterprises are being paid more than those employed in less profitable firms.

Despite the populist overtones to the remuneration revolution which is unfolding, hardnosed economists are likely to be quietly pleased as the world heads toward success oriented pay.

This would be a retracement in the direction previously being urged on western companies. Since the mid 1990s especially, there had been rising pressure on business executives to step away from financial outcomes as the primary sign of corporate success and principal goal of their decision making.

Some called it the triple bottom line. Others tagged it corporate social responsibility. Whatever its name, it involved recognizing that rates of return on investment were not adequate measures of corporate impact. There were social and environmental impacts that also needed to be taken into account in assessing the performance of a company.

However, if companies were to be more than simply cash registers, executives had to be empowered to make choices. Directors needed to decide how the value being created should be divided up: how much to employees, how much to suppliers, how much to shareholders, how much to deserving community organizations and at what cost to the physical environments in which the company operates.

In making the company more socially responsible, executives needed to be able to make a judgement that an employee or supplier, for example, had done what was asked of him and deserved to get rewarded despite the overall financial performance being unsatisfactory from the perspective of a shareholder.

Under this model, the satisfaction of the shareholder was an important but not the primary concern and executives needed the freedom to exercise judgements about the right balance.

Paradoxically, this is precisely the discretion now being stripped from the repertoire of the modern corporate executive as he is forced to make an unequivocal commitment to financial success.

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