66 Business The EconomistFebruary 22nd 2020
2Bartleby Cutting the pie
O
ne of theissues at the centre of the
debate about inequality is the mete-
oric rise of executive pay. The ratio be-
tween the pay of American ceos and
ordinary workers rose from 20:1 in 1965 to
278:1 in 2018, according to the Economic
Policy Institute, a think-tank. The Lon-
don Business School (lbs) recently held a
conference on what caused the rise, and
whether it is justified.
At the conference, Dirk Jenter of the
London School of Economics pointed out
that the pay of chief executives in Ameri-
ca was largely flat between the 1940s and
the 1970s. It then rose spectacularly in
the 1980s and 1990s before flattening out.
What changed in the 1980s was that
executive rewards began to be more
focused on company performance and
share options. The performance-related
element rose from 16% of executive
salaries in the 1970s to 26% in the 1980s
and 47% in the 1990s.
This shift coincided with the great
equity bull market of the 1980s. As West-
ern economies recovered from the stag-
flationary problems of the 1970s, shares
were repriced. The cyclically adjusted
price-earnings ratio (a measure which
compares share prices with a 10-year
average of profits) rose from less than 9 at
the start of 1980 to 44 in 1999. Little won-
der that executives with share options
made out like bandits. But was this down
to their skill, or to the policies of Alan
Greenspan and Ronald Reagan?
Most investors were doing extremely
well during this period, so executive pay
seemed a matter of little consequence to
them. Even now, if ceos were to work for
free, this would not represent a huge
boost to shareholder returns. Average
ceopay of S&P500 companies in 2018
was $14.5m, meaning that executives
collectively took home $7.25bn. In con-trast, the companies they worked for
returned $1.26trn to investors in dividends
and buy-backs that year.
The principal-agent problem plays a
key role. Most shares are owned by profes-
sional investors who work for big fund-
management groups and are well paid
themselves. They have little incentive to
demand big changes in pay structure,
unless salaries look particularly egregious.
The underlying investors—ordinary
savers—have not always done so well.
Take, for example, members of corporate
pension funds. Stockmarket gains have
not been shared equally with them. When
share prices were booming, many compa-
nies stopped making pension-fund contri-
butions. Then in the 2000s, when markets
fell and the cost of funding final-salary
pensions soared, companies closed such
schemes and switched to “defined contri-
bution” plans. These are much less gener-
ous to workers. It is not just that workers’
pay has not kept pace with that of exec-
utive remuneration over the past 40 years;
their pension rights have deteriorated.
A broader justification for high ceopaymight be that businessmen have been
able to make their companies more
efficient and thus transform economic
growth. However, the fastest period of
economic and productivity growth in the
Western world was in the 1950s and 1960s
when ceopay was much lower than it is
today. As ceopay has rocketed, produc-
tivity growth has slowed down.
In a thoughtful new book, “Grow the
Pie; How great Companies Deliver Both
Purpose and Profit”, Alex Edmans of lbs
argues that the wealth accrued by a boss
does not necessarily come at the expense
of others. “Visionary leaders can trans-
form a company, growing the pie for the
benefit of all” he writes.
This makes perfect sense at the level
of the individual firm but is it true in
aggregate? Executives may have pros-
pered since 1980 but this has not always
trickled down to workers. Real median
household income in America grew at an
average annual pace of just 0.5% between
1979 and 2016, before taxes and transfers.
Mr Edmans’s view of pie-growing is
nuanced. He advocates an approach to
business with the primary aim of creat-
ing value for society. Profits are not the
main goal but a welcome side effect.
It is not pie in the sky. Mr Edmans
conducted research about the companies
ranked the “best to work for”, a measure
of whether firms are looking after the
interests of employees as well as in-
vestors. Shares in the firms with the best
rankings outperformed in subsequent
years, even when controlling for factors
like business size and industrial sector.
It is still going to be a big challenge to
persuade companies to reward their
executives on the social value they add. If
that ever happens, the list of best-paid
ceos might be a completely different
from the one today.Is there a better way of rewarding executives?jected by the European oil giants. Traders
whisper that mainland firms are using the
viral outbreak to try to renegotiate terms, a
tactic they deride as “price majeure.”
“fmis a recognised doctrine in civil-law
systems like that of China but is not a doc-
trine of common-law systems, like English
law,” observes Simmons+Simmons, a Brit-
ish law firm. It is typically only respected
by courts in London and Hong Kong if the
contract has a specific fmclause. So local
firms are likely to get a more sympathetic
hearing in mainland courts. Mr Harris
thinks that even if a foreign firm gets a fa-vourable ruling overseas, it may still need
to get it enforced by a Chinese court. That
court will see the fmcertificate and likely
rule for the mainland firm.
Tobias Larsson of Resilience360, a Ger-
man supply-chain consultancy, thinks that
invocation of fmcould help make the fall-
out from the virus the “biggest supply-
chain disruption since Japan’s earth-
quake.” Mayer Brown, an American law
firm, worries that use offmand other legal
tactics “may be passed along supply chains
around the world, causing firms based in
other jurisdictions to seek similar relief.”Still, there is a reason to think legal cha-
os might be avoided. Unlike during the
SARS epidemic, when multinationals
could easily shift sourcing, Chinese firms
are now critical (and sometimes the only)
suppliers of vital parts to many industries.
John Hoffecker of Alix Partners, a consul-
tancy, says that his clients are more con-
cerned about being the first to receive parts
as factories restart than about fm. So for-
eign bosses may agree to renegotiate terms
with certificate-waving vendors through
gritted teeth rather than risk losing them
altogether through bitter legal battles. 7