Essays on Management: Top level remuneration

Remuneration should in theory reflect people’s marginal productivity and their reservation wage – the price that needs to be paid for them to enter the labour market. Top managerial people may be more productive, however the marginal value of an extra dollar to them is lower than for low income people. Top chief executives and managers are paid not for their productivity but because of their bargaining power, and often because of luck and circumstance.

Productivity in a team environment is difficult to attribute to individuals and so rewards become disconnected from individual contributions. In fact, most highly paid people “earn” much more than their marginal productivity or reservation wage, while the greatest contributors to society in science, culture and education earn less. Any society’s Einsteins and Shakespeares are paid a pittance compared to reality TV stars.

How should top level remuneration be determined? The financial cost of “excessive” remuneration may be modest compared to total business turnover and may have miniscule impact on consumer interests. Were the costs of excessive remuneration internalised within a business with no wider impacts excessive remuneration may be acceptable. However excessive remuneration is associated with inequality and can be a form of negative externality damaging to the wider society in which businesses operate.

Excessive remuneration for privileged in-groups demotivates others who may be contributing more to society. It is also used as a benchmark for setting high level public sector, including political remuneration. This in turn means top public servants and politicians have incentives to support excessive remuneration. This morally corrupting self-interest is difficult to challenge because the only people influential enough to do so are part of the same elitist class.

Voters and shareholders struggle to contain excess remuneration because of information asymmetries and because they are too fragmented to exercise the concentrated interest needed to hold politicians, public servants, boards and senior managers to account.
Corporate remuneration is not done in an open competitive market but in a tightly knit and exclusive in-group. People in this in-group sit on boards and are also chief executives. They have every incentive to inflate the remuneration of chief executives they appoint because this sets the remuneration for people within the elitist club they themselves belong to. They have effectively created a narrow labour market sealed off from the wider labour market with entry barriers which reduce competition and inflate social elites’ earnings.

At a time of deep concern about income and asset inequalities, excessive remuneration can be demoralizing for organisations and society. This is especially so when chief executives who lead businesses or organisations are stewards not creators or owners of organisations. There is more comfort with entrepreneurs capturing rewards from the new wealth they have created and the businesses they have built.

Excessive remuneration involves insider reciprocal payoffs within an elitist in-group. In effect, boards and other such remuneration setting agencies turn into self-serving kleptocracies that reward those in overlapping board networks. When people in these networks vote for inflated remuneration they are also indirectly voting themselves an increase. This “reciprocal altruism” then morphs into a kind of potlatch where companies compete to out-reward their competitors in a social elitist hierarchy.

For business leaders and politicians there should be a fixed term renewable appointment, a cap on remuneration and a modest retirement or redundancy package. Four to five year renewable terms are most appropriate for top business managers or politicians and terms should be longer for fields such as science. The chief executive should earn not much more than the next level down – making the point there is a team.

There are counter-arguments supporting high remuneration levels. In tournament theory people strive to be winners and this competition lifts people’s productivity as they compete to do better. However this tournament wastes resources since large numbers of people compete in a competition where only one will succeed. In a race to the top tournament a few winners take all, even though they are only marginally better than the “also-rans”.

Why oppose high rewards for chief executives and not for entrepreneurs? Entrepreneurs risk their own money and bear the consequences of failure. They create new economic space for others and often receive little or no reward for this. Entrepreneurs generate information, technology, new ideas and learning that create opportunities and benefits for others. Most of them fail, or at least are poorly rewarded compared to the benefits they generate. Entrepreneurs are often pioneers who go where “there be dragons”, walk in paths untrodden, clear the land in back-breaking toil and are unrewarded and forgotten. Settlers who come after them colonise the new-found land and reap the benefits, and it is often society’s settlers not entrepreneurs who capture excessive remuneration going beyond their marginal contributions to society.

About Peter Winsley

I’ve worked in policy and economics-related fields in New Zealand for many years. With qualifications and publications in economics, management and literature, I take a multidisciplinary perspective to how people’s lives can be enhanced. I love nature, literature, music, tramping, boating and my family.
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