Executive pay is undermining the public’s faith in capitalism

Question: what connects the leader of a York-based housebuilder with a car executive in Tokyo?

Answer: both have recently been embroiled in scandals over top pay.

Carlos Ghosn, chairman of Nissan, is under criminal investigation in Japan for under-reporting his remuneration to the Tokyo Stock Exchange and misusing company assets. Nissan removed him from post last Friday.

On the other side of the world, Jeffrey Fairburn was recently ousted from his role as chief executive of the UK housebuilder Persimmon, when shareholders decided that the public outcry over his £75m bonus was undermining the company’s reputation.

I would argue that these executives have more in common than their falls from grace. They are both victims of the business world’s performance-obsessed, share-price driven pay culture.

It might seem odd to describe an individual who has pocketed millions of pounds, euros or yen for showing up to work as a “victim”, especially as both Ghosn and Fairburn were strong advocates of the merit-driven bonus schemes that they benefited from.

But the system of performance-related pay, and particularly the practice of rewarding top bosses with shares in their own companies, gave these men the wrong incentives for their jobs.

Let’s leave Ghosn to one side for the moment, as the investigation into accusations of financial misconduct is still ongoing, and focus primarily on Fairburn.

The Persimmon chief’s share-price-linked remuneration scheme was set up in 2012 when shares in the housebuilder were below £4.

Although some shareholders warned at the time that the scheme was too generous, it was not obvious that the government’s Help to Buy plan – announced in 2013 – would drive the share price above £20 five years later.

Initially, Fairburn defended his award, saying that executives had been incentivised by the scheme to drive company growth.

However, with a big boost coming from the taxpayer-funded scheme to help young people onto the housing ladder, the builder’s shares had effectively the advantage of a windfall without any executive lifting a finger.

In Fairburn’s case, Persimmon’s share price was impacted by factors entirely beyond the bosses’ control. But these kinds of bonus schemes can also encourage perverse, counter-productive behaviour from executives, that puts at risk workers’ wages, the stability of the company, and faith in our overall economic system.

Current performance-related pay schemes are giving our top bosses a short-term focus on share prices rather than an incentive to build a company for the longer term.

It is not always easy for a captain of industry to influence shares in a global market – the price is driven by a number of factors such as the health of the overall economy and fortunes of the sector. But one of the ways a boss can boost performance is to cut costs.

This sounds admirable – no one wants a company wasting money. But since workforce wages are one of the biggest corporate overheads, this gives executives a motivation to hold down pay for staff. This could be one reason why we have seen wages growing so slowly in the past decade – so much so that they have not yet returned to pre-2008 levels, despite record high employment.

Another way of influencing the share price is by buying back shares in the open market and cancelling them. This gives a short-term boost, but is ultimately a poor use of funds and not a successful long-term growth strategy.

In my book, I argue for chief executives’ pay packages to be stripped back to basics, removing the performance shares and paying in cash. If shareholders want the executives to own shares in the company, they can buy them with their own money rather than have them gifted.

The present system discourages investment, as it takes too long to pay off, and is a contributing factor to the poor productivity growth in the western world.

And it isn’t just the companies themselves that suffer. The public disaffection with the current set-up and distrust of the business sector, caused partly by executive pay scandals, has undermined faith in the way the economy works.

If capitalism is not seen to be fair, people will be more interested in populist alternatives.

This is worrying for anyone who is in favour of capitalism and a market-based economy. If people have no faith that they will benefit from an economic system, while they see corporate leaders taking home excessive wealth, they could well seek more radical alternatives.

We need to wake up to the problems of our performance-related pay in business before we sleepwalk into a dystopian future.