Rejecting crony capitalism
Alexander Pannett 9.45am
With the City bonus season fast approaching, politicians are talking a lot about the need to tackle “crony capitalism”.
Both David Cameron and Ed Miliband have called for executive remuneration to be made fairer and more transparent.
This follows a paper by Jesse Norman, the conservative MP for Hereford & South Herefordshire, published in December that called for the conservative party to tackle the rise of crony capitalism.
Jesse wrote:
“Crony capitalism arises when economic activity escapes the constraints of law, markets and culture. It is marked by the clash of business activity and the wider public interest, and the separation of business merit from business reward. Value creation is replaced by rent seeking and certain groups become enormously wealthy without taking risk. These factors lead to long-term economic underperformance, and sometimes to social unrest.”
It has been suggested that granting shareholders a veto on remuneration packages and the amount of pay executives receive when they leave a company would produce a fairer system.
However, as Daniel Cowdrill has pointed out on these pages, shareholders in FTSE 100 companies are mostly passive rather than active investors, holding equity for short-term objectives rather than for long term value. They are unlikely to hold back executive pay even if they are given a determining vote on pay levels.
But I disagree with Daniel that tackling executive pay, while difficult, is a minor issue and not worth the political capital. When household incomes are falling across the UK and unemployment is rising due to mistakes that originated amongst our business elites, it is unacceptable that such elites’ pay continues to rise, despite their actual underlying performance, while everyone else shares the pain of the recession.
Research from the Institute for Public Policy Research (IPPR) has highlighted that chief executives in nearly 90 per cent of the FTSE 100 companies took home an average of £5.1 million in basic pay, bonuses, share incentives and pension contributions in 2010-11. This represents a year-on-year increase of 33 per cent, while the average increase in company value was 24 per cent. Since 1999, the pay of FTSE 100 chief executives rose 13.6 per cent every year until 2010, whereas the FTSE itself rose by an annual average of just 1.7 per cent.
There is clearly a severe disconnect from reality in the boardrooms of the UK’s top companies. While encouraging shareholders to be more active may prove difficult, allowing employee representatives to become members of remuneration committees would give such committees more insight into life outside their corporate bubble and would help in setting pay that was proportionate to the real economy.
Greater transparency would also allow for more public pressure and scrutiny to be brought against public companies that encouraged excessive remuneration. Directors should demonstrate that their executive pay does not breach their fiduciary duties to the interests of shareholders. The law could also be changed to give greater power to both creditors and shareholders for clawing back the past pay of executives who caused companies to go insolvent or to suffer periods of particularly poor performance.
Far from being a minor problem, crony capitalism severely undermines the economic health of the UK. When capitalism no longer rewards autonomous risk taking, competition and real increases in productivity, it leads to economic inefficiency as companies consolidate and grow, not to improve performance but to gain elusive economies of scale that in reality are little more than an oligopolistic stranglehold over a market.
The prevalence of crony capitalism marks the wider shift in the UK economy away from real capitalism, which brought social value by serving the actual needs of consumers, to the ideology of the free market that values speculation and short term profits over longer term growth and stability.
Markets should not be the panacea of a new business religion but cultural tools that are bound by mutual dependency and tradition and should be used to address both social and economic problems for the benefit of all society. Rich or poor.
