Corporate greed: Executive Pay is increasingly drawing attention

By Anil Gujadhur

Joint stock companies (JSC) came into being around 1600. One of the most well-known among them is the British East India Company which was chartered by the British queen in 1690. Its original mission was to engage in trade with the East Indies. At the height of its glory and influence, however, it was not only one of the world’s biggest trading companies; it was also running the administration of as big a country as India with army, police, civil service and so on. Companies of this sort are mounted by several shareholders putting their money together (capital) into the venture for undertaking different specified activities (mining, manufacturing, fishing, banking, trading, providing services, etc.). Shareholders are usually private individuals but they are also governments and government agencies where it is the latter that set them up.

For each company, the shareholders appoint a board of directors responsible for directing the affairs of the company. The board, on its part, appoints the executives who will be in charge of carrying out the activities of the company.

As for the shareholders themselves, they look forward to perpetuating and expanding the scope of the company over time and thereby earn profits from its activities. If the company fails, the shareholders lose the capital money they had put into it. Shareholders are therefore the main risk takers in the company.

There are various other forms of business associations. But companies are actually the building blocks of the modern world. In America alone, there are six million companies employing 120 million people and having total assets in the range of 30 trillion dollars. The number of companies has been increasing by leaps and bounds all over the world whether in left-leaning countries like China and Russia or in fully free market areas such as Europe. The world over three million new companies are registered each year. They are the main channel through which the world economy generates growth and employment. But they can wreak great havoc if droves of them are mismanaged or used for personal advancement as the crisis of 2007 demonstrated.

How Big Companies almost destroyed the World Economy

Ever since the financial crisis of 2007 hit the world economy, the doings of companies – or rather their wrongdoings – are coming into focus in many countries. It is widely believed today that the surge of financial activity preceding the crisis was motivated essentially by greed. As financial companies would churn ever-increasing multi-layered volumes of business, they put themselves into a position to earn more and more “profits”. In turn, this got reflected in the payment of huge amounts of bonuses to bankers commensurate with the amount of “profits” they had contributed to bring into the banks.

When the banks crashed, however, it came to light that many of them had incurred so much of loss as to wipe out their entire capital. The IMF estimates that the financial crisis produced total bank losses of $2 trillion. This scale of loss meant that the banks had no capital to stand on. For fear that letting them fail would usher a precipitous destruction of the very economy, governments got into salvaging them by injecting huge amount of public funds to re-capitalize them. Non-banking manufacturing companies hit the bottom along with the banks and global confidence nosedived. Millions of jobs were lost at the middle and lower levels of numerous companies whereas it made headlines whenever one of the top chaps was made to go. The world remains in the down-phase till today.

As things came to light as to how much bankers had contrived to blow up their balance sheets and, together with it, their “profits”, there grew a swirling sentiment of public outrage at what the executives had been earning. Resentment has been growing across countries at the enormous price the public has had to pay to keep those unhealthy “practices” of international bankers going. The big gap in relative pay whereby the top executives will be getting 300 to 400 times the average income paid to workers explains the direction taken by corporate greed at the highest level of management. Corporate debacles associated with such generous practices in favour of the few at the cost of the many have not only scorched the global economy. They have also led to rising inequalities and a collapse of the customary trust people place in business. In a recent survey of trust in the professions, businessmen and bankers came last, along with politicians.

Last week, the Royal Bank of Scotland (RBS) handed out 600 million pounds in bankers’ bonuses despite the bank making a loss of five billion pounds in 2012. The UK spent 700 billion pounds to salvage banks like RBS which had run out of capital in the wake of the financial crisis. On the other hand, the British government has adopted an austerity plan to set its own finances right. It is the public who have been bearing the brunt of unsavoury redress program of UK public finances. In this context, they, the public, are seeing their real incomes fall, benefits cut and taxes rise. The scale of the imbalance between the royal treatment being enjoyed by so-called “performing” executives of banks and company CEOs, on the one side, and the growing amount of austerity imposed on the public at large, on the other, is responsible for the general outspread of huge public resentment against the few highly privileged fat cats walking away with pay on an unbelievable scale by excessive influence in companies.

Signs that Enough was Enough

Switzerland is well known for hosting one of the most attractive financial centres in the world in the centre of Europe, thanks principally to the enormous skill set it has built up over the years. Swiss CEOs and managers are among the highest paid in the world. Yet, the outrage of the Swiss public was at its peak when they went out to vote in a referendum against exorbitant Executive pay on 3^rd March last.

There was a clear sense of public outrage and provocation by an announcement made just before the referendum taken. It related to a decision taken by Novartis AG, a Swiss pharmaceutical firm, that its Chairman will be paid $51 million over the next 5 years to prevent him from going to a rival firm. This was the last straw. 68% of voters agreed to give shareholders sweeping powers to decide on executive pay (i.e., instead of company boards). They decided that there should be no golden handshakes (i.e., when executives quit their posts), no golden parachutes (i.e., payments in terms of stocks, bonuses, etc., to top company executives in case of company being taken over by another) and no signing-in bonuses. They decided that the companies’ board should be elected each year, a clear signal that they understood how close chumminess between directors and executives had wrought so much havoc in the corporate landscape and in the entire economy.

The voters’ decision was that if companies’ executives didn’t abide by binding rules made out by shareholders (not board remuneration committees) in this context, the executives would be liable to three years’ imprisonment and the forfeit of up to six years’ salary. It is unclear yet how the Swiss authorities will translate this popular vote into effective deterrent legislation. But one thing is clear: even a liberal place like Switzerland is finding it difficult to accept the types of excesses we’ve been seeing on the part of big company executives. Boards have been too permissive in the matter of executive pay because of underlying conflicts of interests. A top executive in one company is usually a member of the board of another company. By limiting the pay of top executives in companies where he sits on the boards, he will be limiting his own pay as executive in the company he works for. He has every reason to be as liberal as possible to so-to-say retain “talents” with maximum pay. It will serve him a good turn.

The generalised grievance against abuse by fat cats running companies is catching on. The European Union has also taken the decision to limit bankers’ bonuses to not more than one year’s salary. This will affect places like the City of London which has a history of concocting lavish remuneration packages to get the “best and the brightest” from Wall Street and others. However, unless the European Union looks into the details, the clever guys can circumvent the rule by blowing up the salary itself to astronomical proportions and a one-year’s bonus on top of an inflated salary will make a handsome amount, isn’t it?

Where do we stand in Mauritius?

There are not as many and as gigantic companies in Mauritius as those in other places that have currently managed to shake the global economy to its very foundation. Our companies’ total market capitalisation may not add up to that of even a single large firm, say in the cosmetic sector in France. However, at the scale at which we operate, they are an essential part of the economic fabric.

At the last Annual General meeting of the New Mauritius Hotels, one of the shareholders, Feroz Bundhun, was raising pertinent questions about corporate governance in the group. One had the feeling by the answers given that the board of the company was doing all it could to shield the managerial shortcomings which had produced such a sad plight for the group. No dividend was paid. The reason given for such poor underperformance was a classic one: the depressed state of affairs in the source European market, an argument that almost every other company of some substance in this country has been using to extricate ever more fiscal and monetary advantages. It was unconvincing. The board had aligned its interests with those of management. Whether we will go the Swiss way of electing (not nominating) boards each year and asking shareholders to decide on the amount of executive pay, appears to be out of the question for now.

There is also such a significant concentration of controlling interests in our most important companies that the independence of boards and shareholders is not quite certain. In such a circumstance, major shareholders will prefer to run the whole show, including choosing the levels of remuneration of those they install as executives in the company. Imbalances as we’ve been seeing in the pay scales between those at the top or those close to the major shareholders, irrespective of individual merits, will keep ruling the entire show. The company will bear the consequences as long as it can. That will be the case even if the dispersed minority shareholders did not receive any dividends or were handed out peanuts by way of dividends from year to year. That will help keep warm distribution eventually of the bigger part of company reserves for the controlling shareholders.

One could contemplate, as in the Swiss case, that shareholders of State-controlled companies could come to the rescue in the case of public enterprises. The chances are however those public sector shareholders could fudge it up just the same. For the sake of argument, assume that a company like Air Mauritius was made to purchase an obsolete aircraft that was finding no taker on the market because it guzzled too much gas. Assume also that interested foreign politicians persuaded our decision-makers to go for such a deal in spite of such a handicap. Few at the level of such a public company would dare raise an objection, if at all. If such aircrafts were purchased after all under political pressure, the very viability of the company would be at stake. Risks of this type exist: consider how a company like Air India, once a sterling performer in the airline industry, was brought to its knees.

It would be a good thing if, in the light of what we are seeing as failure of corporate governance in the best economies of the world, we took stock of all that has been going wrong and started redressing our corporate sector’s corporate governance outfit straight away.

* Published in print edition on 22 March 2013