Category Archives: CEO pay

Democracy in corporate boardrooms

In this blog I have written mostly about politics and how innovation could reinvigorate our democracies. I have neglected to apply this principle to the corporate and financial sector. This is actually odd because I spent most of my career in the financial sector not as a “politics student”, or advisor to organisations involved in democratic innovation (what I now do).

An interesting article by Stuart Kirk of the Financial Times (May 25, 2024, “It’s time to let shareholders choose the CEO”), raises the question of democracy within corporations. He challenges the current approach “where elected board members are responsible” for CEO selection. Investors, who own the company, “are never given a list of candidates and asked to vote”. Many of these shareholders own their stakes via mutual funds or pension funds and do not even have the right to vote–that right is executed by the fund manager on their behalf.

Kirk argues that opening up the process will broaden the list of prospects. He also contends this will put downward pressure on CEO compensation which has ballooned in the past decade. Against this contention the recent award of circa $50 billion in compensation to Elon Musk at Tesla is worth pondering. Thousands of retail shareholders were the most supportive of Musk’s package and it was the institutions who were most opposed. Thus, individual shareholders may act in ways that are surprising, and/or arguably counter to their own interests, but at least such decisions will have far greater democratic legitimacy. In the same vein, there is no guarantee that engaging citizens in the political process will achieve better decisions—but they would also have greater democratic legitimacy.

What makes me most uncomfortable about the process of CEO selection in public companies is what I would describe as the “conspiracy of the interested”. Boards appoint new board members—often in their own likeness.  The board-appointed CEO obviously has an interest in placing on the board those most likely to be supportive–and CEOs normally have considerable influence on selection. Boards remuneration committees decide how much the CEO should earn.  It is easy to see how this creates a system where compensation levels remain high, especially as board directors are often CEOs of other companies. Few board members have a genuine interest in depressing executive wages, contributing to the stratospheric rise in CEO relative pay. This all acts to the detriment of shareholder interests.

Kirk makes an excellent point with regard to the investment banking industry where “the internal candidate whose business or region is currently making the most money” gets the nod to become CEO”. As someone who used to follow the investment banking industry, I was amazed at how difficult it seemed to be for investment bank boards to distinguish between luck and competence in choosing a CEO, and how rarely they search outside the company.

The most amazing case of this I saw at close quarters at Lehman Brothers, a firm I knew well (Disclosure: as an analyst and subsequently as Lehman’s Head of Equities in Europe in the 1990s). Richard Fuld emerged from the fixed income side of the business, which had enjoyed record years during the bull market–unsurprisingly he was selected to run Lehman Brothers, systematically displacing any rivals. In my opinion, despite the success in fixed income, he was not a good choice as an investment bank CEO. Fuld, led the firm into a spectacular bankruptcy in 2008, nearly bringing down the global financial system with it. He is reported to have been paid $500 million during his career at Lehman Brothers, according to James Sterngold of CBS News (April 29, 2010, “How much did Lehman CEO make?”), while the taxpayer bill to rescue Wall Street was $700 billion. There is no guarantee Lehman investors would have behaved differently, but the extraordinary preference for internal candidates, which Kirk criticises, is an issue with the current system.

Furthermore, one can argue that Musk created an enormously valuable company and deserves rich rewards. But Lehman Brothers was founded in 1850–is it really fair that at firms with reputations (and franchise value) have been established over decades or centuries, that today’s CEOs gobble up so much of the value created. Perhaps incompetents get fired when their luck runs out but often with generous “golden parachutes”. Heads I win, tails I win–this a huge problem.

It is hard to imagine how one might set about fixing this problem, or even to feel confident that more democratic decision-making would improve outcomes. But as in the political sphere, it seems hard to argue that the current situation is working so well that it could not benefit from experimentation. One answer could be for the fund managers to enable shareholders to vote their shares, so that the institution’s vote reflects the views of beneficial owners. From a technical standpoint this seems eminently doable, but probably few shareholders would bother to vote. But it would be a start and on important issues one suspects the turnout could be much higher. In any event, more democracy seems worth a try—in the boardroom and in politics.

Market orthodoxy, embedded inflation and fair wages

Inflation across the western world is skyrocketing. Consumer prices across the developed world are rising to near double digit levels—levels not seen since the 1970s. Similarly to the 1970s, a rapid increase in the price of oil and gas has been the main contributor. The war in Ukraine has catalysed a surge in energy and grain prices, and both are causing wider knock-on effects.  This is causing one of the worst cost of living crises in modern times.

Governments and central banks are rightly concerned about rising inflation. It imposes extraordinary hardship on citizens (especially the poor) and squeezes government budgets. On top of this there is a concern that inflation, which with substantial effort and cost appears to have been eliminated in the 1980s is now returning with a vengeance, thus threatening to undo all that arduous work.  The fear is that inflationary expectations get ‘embedded’ into the economy thereby making it harder to control.

Interest rate increases are a tool of central banks to bring inflation under control by dampening demand. Higher rates raise borrowing costs which, at the margin, reduce economic activity. However, in the current environment, it is ridiculously hard to argue that the economy is overheating—far from it.  The global economy is very weak due to Covid, the war, and other factors, but the primary cause is the massive increase in energy costs.  Raising interest rates will weaken growth and do nothing to address the cause of higher inflation.  Their effect will be to push the world economy into a recession.  This might have been a time for REDUCING interest rates, had central banks acted more prudently in past years.  I suspect they were under pressure from the finance sector to keep money loose, which supported asset prices—and this seemed excusable with inflation at seemingly low levels.  Now we are paying the price for this error.

Let’s return to this idea of embedded inflation and how to address it.  Inflation “getting embedded” is a euphemism used by officials for wages which (heaven forbid!) might match inflation.  Central banks and many governments are nearly hysterical about the need to resist this at all costs.  There is no matching angst regarding corporate profit margins—or CEO pay, for example.

The chart below illustrates the share of GDP in the United States which is represented by labour or corporate profits[1]. Notice how labour share of profits has fallen since the 1970s at the same time as share represented by corporate profits has risen sharply.  Maybe its time for some reversion of corporate profits to the historical mean?   Perhaps companies can help prevent inflation from getting embedded by raising prices at less than the increase in costs?  Profit margins might suffer a bit (from historically high levels!)—but is this not preferable to forcing the lowest paid to make choices between heating and eating?

And why do the arguments about “irresponsible pay increases” only apply to low paid workers?  It seems that CEOs have no worries about their own role in embedding inflation.  The chart below[2] shows how US CEO pay packages have risen in comparison to the pay of workers.  Is it simply inconceivable that only average workers should suffer as we ward off embedded inflation?

The next chart[3] shows how labour’s share of output has steadily declined, especially in developed economies.  Is it not time for some correction?  Given labour shortages across the western world, is there not a simple solution to entice staff back to work—just pay them more!  Why does the market orthodoxy of supply and demand only apply in the case of CEOs or banker’s bonuses (the UK just loosened the cap on banker’s bonuses, amidst this cost of living crisis)?  Do only the high-paid need to be “incentivized”?   

Paying workers in line with rising inflation in the current environment is hardly inappropriate–in fact, it’s essential, and any decent objective observer would say the same—in fact, they might say its time workers to catch up a bit.  However, I do not hear this at all. Yes, labour union leaders seek more money for their members, but I do not hear the broader point that in the interest of the nation we simply must reallocate between corporate profits and workers.  And why should these pay increases only approach the rate of inflation? Why should they not match or even exceed it? And while it is true that in the short term profit margins may suffer, we will avoid a social and economic cataclysm.  I also believe that the trendline of economic growth will accelerate if we undertake this shift. The poor and those on moderate incomes have a much higher propensity to spend any incremental income–it is sensible from a growth perspective that we put money in their hands instead of continuing to enrich the rich and the owners of assets.  Who is more likely to spend incremental income, the rich or the poor?  No points for a correct guess.  (I may write a separate blog post on this subject.)

That companies simply “have to” pass on costs (labour or materials) is just taken for granted–almost as a natural law of physics. However, the notion that workers should receive pay increases which support them to keep up or just about keep up with the rise in costs is heresy of staggering proportions. This orthodoxy needs to be challenged.

This is not just about markets, but political choices.  Governments are restraining pay increases for low-paid public sector workers to grapple with inflation.  What they should do instead is pay these workers more, raise funds to cover rapidly rising debt levels by increasing personal taxation at the high end (and lower it at the low end?), increase (not decrease, as the UK is proposing to do) corporate tax rates, and they should, as some countries are, institute “windfall taxes” on energy companies for the unusually elevated level of profits realised merely as a result of the war.  Failure to do so risks social unrest, poor health outcomes (as the poor starve, freeze and are unable to procure health care) and economic weakness as demand suffers.  In any event, they should junk the rule that says workers always have to shoulder the burden of fighting inflation.

A courageous politician would seize on this theme. Where is he, or her?

Rodney Schwartz

London, UK–14 October 2022 

I started my career in mainstream finance and shifted into impact investing before returning to my lifelong passion of politics in early 2021. This blog reflects that return and is my way of sharing the impressions of someone journeying from “proper jobs” in the investment world back into education to study politics after four decades. For those interested in why I started this blog click here, and to read my declaration of known biases, click here. I welcome any comments.

[1] Taken from a PGIM (division of US financial firm Prudential Financial) Fixed Income Division report, dated April 2021, written by Nathan Sheets and George Jiranek, downloaded 17 August 2022

[2] Financial Times, 13/10/22

[3] Financial Times 12/10/22