Company managers need to hand back control to shareholders

Shareholders meeting © Getty Images
Companies belong to the shareholders, not superstar CEOs

I’m assuming that most readers have found enough things to worry about for 2017. But those who haven’t might look to the Hebridean island of Rum, where Scottish Natural Heritage (one of Scotland’s many charities devoted to protecting stuff) has announced that if someone doesn’t give it £20m sharpish it might have to bulldoze Kinloch Castle, a castellated Victorian mansion variously described as “magnificent” and “ remarkable” by its supporters, mostly other charities devoted to protecting stuff.

It’s an interesting place, though not so much for its architecture as its origins. It was built by the 27-year-old Sir George Bullough in 1900 as a pleasure palace. It had its own electricity supply (hydro); proper heating; a mechanical “Orchestrion” able to replicate the sound of a 40-piece band; some pretty impressive en-suite bathrooms; Scotland’s first internal telephone system; and, to greet visitors on the way into the ballroom, a large nude portrait of Bullough’s wife (drinking tea, as you do).

How, you might ask, did Bullough get the money for all of this (around £15m, inflation linked)? Simple: he inherited it all from his hardworking industrialist father, a machine manufacturing magnate in Lancashire.

If you’ve spent some of this week thinking about Jeremy Corbyn’s witterings on income inequality you’re probably now thinking what I’m thinking: there’s no need to knock the place down. No no no. Instead, all we have to do is wait for one of today’s top chief executives to pop their clogs and one of their luxury-loving heirs to want their very own pleasure dome. Then we can flog it to them.

After all, if your dad has been pulling in £10m a year for ten years, you should, even after you’ve paid your inheritance tax, have enough to fix Kinloch’s roof, redo the moss in the Japanese gardens and commission the yacht you’ll need to get back and forth, with a few tens of millions left over. Buy in a few humming birds and alligators (yes, Bullough had these) and the job’s done.

This, of course, brings us to Corbyn’s first and totally correct point. Some people are really overpaid. If a chief executive can make enough money to change the fortunes of his family for generations to come in just a couple of years — something only real entrepreneurs and risk-takers could do back in the days of Bullough’s father — we have a problem.

It also brings us to his second, also entirely correct, point: something must be done. Unfortunately, that’s the end of the totally correct bit of Corbyn’s thinking. His “something” in this case (the now-abandoned absolute cap on pay at a level somewhere above his own earnings) is similar to a lot of his somethings: it demands that we address symptoms rather than causes.

If we disapprove of the huge payments going to the top management of public companies instead of to their shareholders (at the bottom as well as the top of the size scale, by the way) we shouldn’t demand legislation to stop it, we should look at the environment that allows it to happen and have a go at fixing that.

This is partly about giving more power to ordinary shareholders. Back in 1953 over 50% of UK equities were owned by individual shareholders. By 2010 that had gone down to 11.5%. Today we don’t deal with our investments ourselves: we tend to hold our shares via middlemen — fund managers of one kind or another — and we rely on them to take care of corporate governance for us. We don’t turn up at AGMs to argue over £5m here or there (usually no one tells us when the AGM is anyway). We expect them to do it for us. Unfortunately, they usually don’t. So we need a system where the ordinary investor is re-engaged with the corporate world. Perhaps we should all be sent voting forms to fill in. And perhaps fund managers should be obliged to use our votes as we (rather than they) see fit. This might have been tricky ten years ago, but what with the internet, it really shouldn’t be now.

At the same time, as Theresa May has suggested, votes on remuneration need to be binding. Shareholders are, in theory at least, the owners of listed companies. What they say really should go. And I suspect that, given the chance, what they will say is “enough with the entrepreneurial-style payments to mere managers”.

But this isn’t just about shifting power from manager to owner. It is also about the systems that create the results that allow managers to be so well paid in the first place. Think debt. Governments the world over allow companies to offset debt interest against tax liabilities, something that effectively favours debt finance over equity finance.

There are all sorts of consequences to this: as Andrew McNally points out in his book Debtonator, if companies habitually use debt instead of issuing new equity, the results of any productive activity always accrue to the same small group of people (note how the US equity market is actually shrinking, for example). This concentrates rather than distributes wealth.

And if companies use today’s super-low interest rates as an extra incentive to finance more debt to buy back shares, they compound the problem. Share buybacks cut the number of shares in issue. That pushes up earnings per share, which then pushes up share prices, the combination of which has, of course, pushed up payouts from management incentive plans across the board.

The way we all treat debt could therefore be considered an interesting factor in both the wealth and income inequality debates.

Good news, then, that not only has the UK government been consulting on the matter, but that there is a neat little disrupter nestling in Donald Trump’s corporation tax plans: the elimination of the ability to deduct debt interest in an attempt to put debt and equity on a level playing field.

Corbyn appears to agree with Trump on all sorts of things (protectionism, fiscal expansion, limited free movement of people and so on). If he really cares about inequality perhaps he can lobby for this Trump policy in the UK too (before Theresa May beats him to it). That would be interesting — even if it did eventually mean Kinloch Castle being turned to rubble.

In the meantime, investors who want to stay on the right side of political trends might want to think about a fund that particularly focuses on avoiding firms with high levels of debt. McNally’s Equitile Resilience Fund is a good place to start.

• This article was first published in the Financial Times

  • Mark Bishop

    My guess is that Trump’s proposal to end the tax-deductibility of debt servicing will be lobbied away. It harms the interests of banks and magacorp CEOs, two of the three most powerful constituencies in the US (the third being gun manufacturers.) But I hope I’m wrong, as the equalisation of the treatment of debt and equity would eliminate perverse incentives and benefit most stakeholders.

    As for senior executive pay, for me the answer is not a cap but rather the empowerment of shareholders – including the underlying owners of equity, when shares are held in ETFs, investment trusts and unit trusts. If the company’s backers are happy to pay their CEO handsomely, anyone who disagrees should buy shares in the firm and exercise their votes accordingly.

    The trouble, of course, is that even direct shareholders these days mostly don’t get to vote (sharedealing platforms hold shares in nominee accounts); and as for collective schemes, their managers are equally lavishly rewarded so may not see a problem; even if they do, if their career aspirations include non-executive roles in the future, why rock the boat?

    A share-owning democracy is an electoral promise that played well back in the 1980s. While Jeremy Corbyn isn’t the obvious candidate to repurpose it for the Millennials; but in the current, populist atmosphere, I believe the first to do so will win some electoral support.

  • Momoko Miyamoto

    Corbyn recently paraphrased J. P. Morgan who once said that he would never lend money to a company where the highest-paid employee was paid more than 20 times the lowest-paid, as it was in his view unstable. Corbyn then went on to say that 20 times the living wage is around £350k. 350k is plenty of pay for any employee, if people want to earn more then they should be free to start their own company and risk their own capital. Perhaps an interesting proposal would be if high earning employees earning above an upper limit (e.g. £400k) have to waive their employment protection rights as a condition of high pay. So they can be easily and cheaply fired if the shareholders no longer feel that their reward is merited. Golden goodbyes should be outlawed too as they are simply rewards for failure.

Merryn

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