Thanks to last year’s war-driven energy price hikes, recent performance-related pay awards for chief executives in the oil sector have been beyond extraordinary. Profits have ballooned, causing boardroom pay to rocket.
Leading the field is ExxonMobil chief executive Darren Woods, whose $36 million (€32.8 million) pay last year was up 52 per cent from 2021. Then there is BP’s chief executive Bernard Looney, whose package more than doubled to £10 million last year. Not far behind: Shell’s former chief executive Ben van Beurden, who received total pay of £9.7 million, up 53 per cent from the year before – all in the first year of the cost-of-living crisis.
Big Oil would have us believe that these payouts are a just reward for managerial wizardry. But however talented (or otherwise) these CEOs may be, do not doubt that luck played a substantial part.
And escalating inflation also causes random distortions because metrics used in performance-related pay are based on historic costs unadjusted for inflation. They do not reflect the escalating replacement cost of inventory, plant and machinery or the falling value of money.
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The result is eye-popping inequality between the boardroom and the factory floor. According to a survey of 350 of the largest US-quoted companies by the Economic Policy Institute, realised CEO pay, including proceeds from equity shares and stock options, rose 1,460 per cent from 1978 to 2021. This compares with 18 per cent growth in typical worker’s pay over the same period.
The same survey shows that the CEO-to-worker pay gap rose from 20 times in 1965 to 399 in 2021. Awards in the UK are less elevated but spectacular nonetheless. A joint High Pay Centre and TUC survey estimates that median FTSE 100 CEO pay in 2021 was 109 times that of the median full-time worker, up from 79 times in 2020 and 107 times in 2019.
This inequality is demoralising for workforces and fosters the impression more widely that a tiny elite is grabbing a disproportionate share of the spoils of capitalism – a recipe for ever-increasing populism in politics.
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How did it come to this? Seminal in the creation of the bonus culture in the US and UK was a 1970s paper by American economists Michael Jensen and William Meckling. They highlighted the lack of management accountability arising from the separation of ownership and control in quoted companies.
The Jensen and Meckling solution to this principal-agent problem was to align managers’ interests with those of shareholders (principals) by giving managers (agents) a significant equity stake. Yet the beguiling notion of alignment reflects an absurdly over-simplistic view of boardroom motivation and of the structure of the equity market.
Every chief executive has a personal balance sheet with different levels of indebtedness. This, along with their varying expectations about their likely tenure, has a profound impact on their risk appetite. CEOs’ moral compasses, and thus their readiness to feather their nests at shareholders’ expense, vary widely. None of this is disclosed, so ignorance prevails over the executives’ interests that agency theorists wish to align with shareholder interests.
As for shareholders, they have different time horizons and risk appetites. They are certainly not the residual risk-takers of the capitalist system as agency theory posits. Institutional ownership means that bankruptcy risk is diversified across huge portfolios. Yet managers’ risk cannot be so easily diversified.
Equally problematic is that performance-related pay metrics are flawed. Those in which the share price is a key driver rarely distinguish between company-specific share performance and the movement of the overall market. Those that rely on earnings per share can be easily manipulated, notably through share buy-backs, which boost earnings per share while weakening balance sheets.
That helps explain why the value of big oil companies’ buy-backs and dividend payouts now vastly exceeds their investment in renewables. And, as the British economist Andrew Smithers has convincingly shown, the bonus culture largely explains the decline in investment in the US and UK along with low productivity growth.
In a sane world, CEO pay would be primarily in cash with equity used only for truly exceptional performance.
Smithers argues for a more investment-friendly tax system and for bonuses to be conditional on improved productivity. But this will not happen because CEOs love rewards for luck and have lobbying power. The astonishing failure of corporate governance and investor stewardship over executive pay will not be remedied any time soon.
– Copyright The Financial Times Limited 2023
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