The Price of a Good Executive

Crony Capitalism and Aligned Interests

We heard recently of Haruka Nishimatsu, Japan Airlines chief executive who has slashed his own salary to less than that of his pilots. The airline is in trouble. It is bloated with costs, a not insignificant component of which is staff salaries. He is going to lead from out front.

Executive salaries have been in the news lately. The unbelievably large payments made to senior Wall Street executives has America, including its new president, hopping mad. Self-gratifying chief and senior executives have been cited as a symptom of what is wrong with "unbridled capitalism" and an indicator of why the "free market" has failed.

Anyone who knows anything about free markets knows that the dynamic of creative destruction is at their core and that huge companies going bust is a proof of the free market working, not failing per se. The real issue is how the international free market system was allowed to get so far out of kilter, requiring such a large and calamitous correction. And it is at that point that we start to find that it was government interference and legislative distortions which have been substantially to blame. Governments essentially "de-risked" large parts of the commercial system in the name of a "higher social good" leading to and encouraging very speculative behaviour.

If corporations believe that in the end the government will pick up the tab, the moral hazard is unavoidable--corporations are free to engage in more and more risky behaviour. When business is protected by implicit government bailouts, or guarantees (as was the case with low grade mortgage financing the the US) the desire for more and more speculation is inevitable. It becomes irrational and commercially irresponsible not to participate and play the game.

The result for a time is higher and higher profits, carried forward by ever higher levels of debt. Executive payments rise accordingly. Shareholders tend not to complain at outrageously high executive bonuses and remuneration packages when earnings are rising and share prices are inflating upwards. Once again it turns out that governments are the problem in the first place, not the solution.

Thus the failure has not been caused by unbridled free markets, but a failure because of the lack of them. A free market is after all a market where private property (as guaranteed by the eighth and tenth commandments) is exchanged for a mutually agreed price. The only biblically legitimate interest of the government in such a market is the enforcement of contract and the punishment of fraud and theft.

The present failure has been caused by far too much crony capitalism--a cosy self-serving conspiracy between neo-socialist politicians seeking electoral support from the poorer classes and a mortgage industry in the United States and elsewhere able to operate without apparent risk. Which is to say, the risk was transferred to the taxpayer. Therefore, they were free to grow recklessly. Which meant they could grow rapidly, which meant, in turn, that staff--especially senior executives--could get paid outrageously. It was great work if you could get it.

Now, at first glance one can understand why senior executives in the big Wall Street firms used public money to make sure they got their huge bonuses again this year. After all, they were only calling in the guarantees they rightly believed had always been there. It's a bit churlish of politicians, Barack Obama included (as he was a staunch supporter of this particular version of crony capitalism), to criticise their paypackets now--since implicitly the US taxpayer has been funding them and underwriting them for years.

But politics is a fickle business and yesterday's grand alliance is today's dirty linen. The voters also are up to the necks in the whole tawdry business. They went along with the conspiracy. They were more than happy to get their subsidised loans and move into their new houses--which could only be afforded if a bigger fool came along after them prepared to pay a higher price than they had paid. It was free money as long as it lasted. They looked to their politicians to make sure that occurred--and used their votes accordingly.

They bribed the politicians, even as the political leaders bribed them. (By the way, why is everyone so upset about the Madoff Ponzi investment racket? He learned his trade from the crony capitalists and suborned voters and politicians, who ran the biggest Ponzi scheme in history. It was called Federal support for low-income housing. So big was the scam it has threatened the stability of the entire global financial system. Madoff was merely an imitator and thus their flatterer. Why despise him now?)

So, now the guarantees (explicit and implicit) have been called in and the taxpayer is paying up. Weep for your children and the slave collar of debt they and their children's children will likely bear as a result. Pagan governments always--always--act and move over the long run so as to enslave their people. And so it has proven true again. America, the land of the free, is rapidly devolving into a country of slaves. (We, in New Zealand, are well ahead, far further down that particular track. Here, the number of households directly and indirectly receiving income from government and government agencies is now far greater than those which do not. Entitlement socialism will lead to a rapid rise in public debt over the next few years--at least if the Treasury's forecasts are credible. So far in this economic crisis, their projections have proved too rosy!)

Will the situation improve? Not likely. On every hand there are calls for more, not less crony capitalism. So you need to be thankful for small mercies. And we think we have such a small step in the right direction in the US with Obama's insistence that executive salaries be capped at half a million dollars for those corporations which accept government capital. It is a small victory amidst a great mess. But, we will take what we can get.

What Obama's move shows clearly is that government money means government ownership. It comes with an owner's strings. The government is now a defacto (and large) shareholder in a growing number of US companies. An owner of a business has a right to stipulate executive salaries, does he not?

But the fine print on government supported executive remuneration is encouraging. Companies, while prohibited from paying above a certain level in salaries, are not prohibited from granting their executives bonus shares. Now this is not free. It has a cost. It costs existing shareholders because their shareholding is diluted, but then all staff remuneration is a cost to shareholders. Remuneration is a cost of business and shareholders own the business. But the bonus shares can only be accessed when the government is paid out, with interest.

Aligning managements' interests with shareholders and owners is never easy. No system is perfect. But the critics of Obama's stipulations have completely missed the mark.

One criticism is that no executive worth his or her salt will bother with such a mickey mouse arrangement. They will just move on to where they can attract higher income. Good riddance. If senior executives are not willing and eager to align their pockets with those of their owners and shareholders, get them off the ship. They have talent no-one needs. It is simply too destructive and costly in the long term. We believe that genuine, honest, capable and shareholder-committed executives who think beyond themselves and their immediate pay packets will rise to the top. Obama's stipulation is a way of sorting the wheat from the chaff and is a good move.

Another criticism comes from the envious who complain that "handcuffed" bonus shares will result in senior executives reaping huge profits in time because if corporations are restructured, stabilised, moved back to profit, and repay the government with interest, the share price of the company will have likely risen substantially. Executives will therefore be handsomely rewarded when they cash in their shares. True. And the problem with that is . . . ? Which one of the prior conditions listed above would you reject as unacceptable? Well, my envious friend, we believe it is appropriate to pay for a job well done. This way, the payment is not made unless the job is well done. The interests of the executives are aligned with their owners--and that is a very, very good thing. It is what crony capitalism subverted and suborned.

So, a small accomplishment, which may have a large and beneficial impact. We salute President Obama on this one.