Fat Cat Thursday

Today is Fat Cat Thursday. It marks the fact that in just three working days Britain’s top bosses will have earned more the average full-time employee will over the whole year. The High Pay Centre (who publish this stat) argue that this is evidence that CEO pay is too damn high. The Times believe that executive pay is damaging the reputation of free markets. And the Prime Minister agrees, she thinks that firms that offer CEOs massive pay packets are ‘the unacceptable face of capitalism’.

Hogwash! CEOs are paid handsomely because the decisions they make are so important. When Microsoft’s CEO Steve Ballmer waited too long to invest big in smartphones, he destroyed share value magnitudes higher than his pay. The right CEO can take a firm to the next level (e.g. Steve Jobs at Apple) and the wrong CEO can bankrupt a firm. Is it any wonder that firms are willing pay millions to get the right one?

Some argue that while CEOs are important, today’s CEOs are no more talented than CEOs ten-twenty years ago. They bring up the fact that over the last ten years executive pay has risen by 80% while returns to shareholders have only increased by 1%. But, as Sam Bowman points out that comparison is misleading. CEO pay (£525m) is just a small fraction of returns to shareholders (£75bn in Dividends). 1% of a very big number (1% of £75bn is £750m) can be worth more than 80% of a much smaller number (80% of £525m is £420m).

It is the equivalent of arguing that spending on cybersecurity has quadrupled but profits are flat. That may be the case, but it doesn’t imply spending on cybersecurity is a bad idea. As Intel found out today.

When I debated the High Pay Centre’s Stefan Stern on LBCthis afternoon he argued that, paraphrasing, today’s CEOs are no more talented than CEOs in the past, and so questioned why they should be paid more. They should be paid more for the same reason Harry Kane is paid more than Alan Shearer. CEOs, like Premier League footballers, have become relatively more valuable. Just as Premier League matches are now screened across the world. This is backed up by research from Quigley, Crossland and Campbell. They looked at unexpected CEO deaths and their impacts on share prices. This allows them to control for the fact that when CEOs are fired, even more bad news is often revealed at the same time. They found that since the 50s while good CEOs cancelled out the impact of bad CEOs, share price changes in either direction were much higher.

Why’s this the case? I can think of two big reasons.

1. Globalisation

Globalisation has increased the risks associated with bad decisions but also increased the reward associated with good decisions. If a CEO makes the wrong investment, it could lead to an international competitor snatching market share. On the flipside, the potential upside of being a market leader not just in the UK but also the US, China and Japan means that good CEOs are more valuable.

2. Intangible Capital

As Stian Westlake and Jonathan Haskel argue persuasively in their book Capitalism without Capital, business today is as much about tangible machinery as about branding. In the past, if General Electric’s CEO overinvested in microwaves and under-invested in cars, they could at least sell those machines on to other firms. Perhaps not for as much as they paid, but not for nothing either. That’s not the case with branding. Take Burberry, before Angela Ahrendts became Apple’s top paid executive, she was in charge of turning the Burberry brand around. When she joined, it was a downmarket brand tainted by its association with ‘chavs’. She made the call to close factories to reduce counterfeits and cut out cheaper products. As a result, Burberry once again became a luxury brand and the fashion house’s share price more than doubled. If Burberry hired a different CEO, the brand might have been permanently associated with bad taste. You may be able to sell off a sewing machine, it’s much harder to sell off a tainted brand.

If CEOs are as valuable as stock markets think (and remember if they are wrong there is big money to be made) then crackdowns that scare off top talent could be a disaster for British businesses.