Paid to Star not to Mar

Some commentators on the doings of the banking royal commission figuratively raise their eyebrows at the salaries paid to senior bankers. “A nice earner if you can get it.” Me, I don’t get fussed about some businesses willingly and legally paying certain employees large sums of money. That’s their call. On the other hand, it is galling when those receiving such sums prove to be negligent or, worse, shady; particularly when they cause collateral damage to ‘innocent civilians’. That’s the real crime.

The salaries of all those in the upper echelons of corporate life are nowadays far above what they were in earlier times. Rounded, the latest figure which I have found show CEOs of top companies earn around 300 times a worker’s average salary in the US, 130 times in the UK and 80 times in Australia. If we were to go back fifty years the gaps were far smaller; for example, about 20 times in the US. A similar story of rising disparity applies in the UK, in Australia and elsewhere in the developed world. What to make of it?

I was once chief economist for the largest state-based bank in the 1980s. The bank had been in existence since the late 19th century. As with all Australian state and regional banks at the time, it specialised in accepting retail deposits and lending for housing. This was by far the most of its business. It was a profitable and safe business which required no great intellectual or entrepreneurial firepower to run it.

The new CEO and those he brought in (which included me as a peripheral actor) had a brief to expand the bank’s operations into corporate lending. It was rumoured that sizeable salaries had been paid to attract the requisite corporate talent. What a disaster it all turned out to be.

The bank went down in 1991. Australian banks suffered badly during the 1990/91 recession. Arguably, others would have gone down but for the support of the Reserve Bank. Most held poor quality assets, put on their books by highly paid bankers. The defining catastrophe for the bank that I worked for was its ruinous ownership of a merchant bank subsidiary; run by a highly-paid Young Businessman of the Year (1986) who “made reckless [lending] decisions on inadequate information.” (Woodward Royal Commission)

Why am I telling this tale of woe? It is to point out that the price of failure can be very high in the business world. Undoubtedly, in retrospect, in view of the bank collapsing, the salaries of those brought in to take the bank to new horizons were, to put it mildly, excessive. But this has to be also looked at from a different angle. Exactly how much would someone be worth who could have prevented the bank’s failure and turned the situation around? “A lot” is the answer.

Boards and shareholders face a stark choice. Take the CBA (which I have chosen only for illustrative purposes). Its market capitalisation is about $126 billion and, at last count, its net profit was near to $10 billion or 8% of its market capitalisation. The board knows, from experience of the corporate world, that a new CEO could potentially take profitability up to 9% or down to 7%. That is a swing of $2.5 billion. Now how much is the right person worth? My illustration is not in the least stretched.

Businesses of all kinds risk putting people in senior positions whose decision-making might turn out to be seriously wayward. I have singled out banking because I have first-hand experience. But take mining. I owned shares in BHP when it bought shale oil assets in the US and lost billions and when a tailings dam in Brazil, for which it had shared responsibility, burst killing nineteen people and covering villages in a deluge of unpleasant mud. As a shareholder (part owner) I ‘deservedly’ lost a considerable amount of money (for me). My dividend at one point was cut from 60 cents to 16 cents per share. I can’t recall the directors or the senior executives correspondingly cutting their salaries by three-quarters. The chairman of the company during this period of my loss was named a Companion of the Order of Australia in June 2017, in part for his leadership in mining. During his tenure the share price of BHP fell from around $38 in March 2010 to a little over $26 in August 2017.

As soon as Wesfarmers bought the Homebase chain in the UK, I sold my shares. I’m a slow learner but a learner. I know the UK and thought that it didn’t match well with the Bunnings model. But some highly-paid executives evidently thought that it did. The result, in early 2018, a write down of over $1 billion.

Better people in charge of BHP and Wesfarmers might have made decisions which would have saved many, many multiples of whatever sized salaries were paid to them. Equally better people in senior positions in banks might have avoided letting financial advisors and planners dud their customers.

Larger businesses are larger than they were decades ago and operate globally much more than they did. Competition is stiffer. There is less room for error. The rewards for success and the penalties for failure are more evident. Getting the right people at the top is defining. Whether they are paid, say, $5 million or $10 million or more is a trivial detail. An English football analogy is apropos.

When I was a lad supporting Liverpool FC, the club’s leading player was my hero Billy Liddell. He was paid £20 a week, about 60% more than the average working wage at the time. Liverpool signed Mohamed Salah from Roma last year for £34 million and gave him a salary of £90,000 per week on a five-year contract. His salary pales against the value he has brought to the club. It is reported that he will be offered a new contract worth £200,000 per week. Is this too much? Supporters on an average wage of a little over £500 a week don’t think so. They don’t want to lose him.

In a market economy, top-end salaries are set by competitive forces. We should not get into a funk about CEOs taking home millions, even tens of millions of dollars. Leave that to nutty left-wing economists and politicians rabbiting on endlessly and mindlessly about inequality. An individual worker at ‘the coal face’ has no measurable influence on the performance of a large business. A CEO and those immediately around him (or her) have a defining influence. We should reserve our ire for those paid a lot who deliver losses and injury.