News this morning that executive pay in big UK companies rose by 10% in the past year, about five times the rate of increase in average earnings. My question is rhetorical. This latest manifestation of economic opportunism by the executive classes (that is, seeing what they can get away with) is of course unseemly as well as immoral. But what of the economic drivers? My old favourite, Oliver Williamson’s The Economic Institutions of Capitalism, was published in 1985. It notes that earlier discussions of governance, at least since Berle and Means, had paid little attention to the role of management, but the book’s own perspective on management does not discuss the reasons for the power of executives. After all, they were not yet flaunting it, and the book pre-dates the modern greed-fest.
I think the explanation requires a beefed-up principal-agent asymmetric information approach. Intangible value accounts for a massive proportion of the market cap of all large corporations, and it is impossible for any party other than the internal executives to monitor the contribution of those individuals to the value of the company. In fact, executive pay structures have also become a signalling device to indicate the individual’s contribution. (Are there any models of this kind around? I’m not up to date with this bit of the literature.) Shareholders, workers and customers alike have to trust the board. Looking at this morning’s reaction to the latest pay news, I rather think that trust has been torpedoed.