Why Great Bosses Make Millions

As every spring, with the publication of the reference documents of listed companies, the remuneration of big bosses provokes indignant reactions. This year, a study by Fintech Scalens, a platform specializing in services for listed companies, showed in particular that the leaders of the CAC 40, the forty most valued companies on the Paris Stock Exchange, saw their compensation double in one year, reaching an average of 8 .7 million euros. Same uptrend in the US: Top 100 US leaders saw their pay rise 31% in 2021 to settle at around €20m per person on average (including +569% for Apple boss Tim Cook, or even +65% for Goldman Sachs).

One name in particular caught the attention of the French press: Carlos Tavares, general manager of the Stellantis automobile group (born from the merger between Fiat Chrysler and PSA Peugeot-Citroën), who was supposed to receive 66 million euros in remuneration. in 2021, including a fixed tranche of 19 million euros. This number, made public between the two rounds of the presidential elections, was considered “shocking”both by the candidate for the National Assembly, Marine Le Pen, and by the candidate for president Emmanuel Macron, who also called for a ceiling on the remuneration of leaders at the European level.

In fact, the case of Carlos Tavares seems even more controversial because, under the mandate of François Hollande, a law was adopted so that the employer’s remuneration is subject to shareholder approval. On April 13, the latter also opposed the payment of 66 million euros at the group’s general meeting. But the vote, which took place at the new headquarters located in the Netherlands, has only an advisory role… “However, we were assured that it was for geographic neutrality, not financial advantages…”

performance decorrelation

During the Stellantis Group’s General Meeting, Chairman John Elkann justified this level of remuneration by explaining that he wanted to “performance reward” of the leader who brought about the merger between Fiat Chrysler and PSA Peugeot-Citroën.

However, the question of rewarding success financially, while it has been widely debated in psychology since Edward Deci’s seminal work, is not what is at stake here. What is shocking is the level of this reward. How can we explain it? Is this a relevant management practice?

In the United States, managers earned an average of 254 times more than their employees in 2021, compared to 238 times in 2020. A level close to that observed in France. However, if the sheer level of this difference can legitimately shock, it is above all its evolution in recent decades that constitutes the most surprising phenomenon.

In fact, this gap was only 1 to 20 in the United States in 1965. It was also the maximum recommended wage gap in the early 20th century.and century; the famous banker JP Morgan, little known for his egalitarian activism. What can explain this inflation? It is certainly not a proportional increase in the talent and responsibilities of the bosses: whichever indicator is chosen, there is no indication that the performance of leaders (and the companies they lead) has multiplied by 20 since the 1960s.

inbreeding of the council

In fact, the explosion in the remuneration of managers of listed companies is explained by the conjunction of two perverse effects. The first is the consanguinity of the management and supervisory boards, known in France by the sweet name of “barbichette”, in reference to the lullaby “I hold you, you hold me by the goatee”, which becomes: “You are a member of my board, you vote my compensation, I am a member of your board, I vote your compensation”.

To legitimize executive compensation, some argue that there is a “market” for talent and that compensation, no matter how exuberant, corresponds to the “market price” of skills. However, if such a market exists for the leaders of large groups, it is certainly not a free market, and price is certainly not an objective measure of value. In fact, the boards of directors of the listed groups are often made up of individuals who are leaders and who often sit on several other boards.

Paradoxically, it is the publication of wages that has caused its inflation.

There is, therefore, a form of collusion more or less manifested between managers and those who evaluate their performance and decide on their remuneration. Furthermore, this situation is not specific to French capitalism (although collusion between alumni of the same Grandes Écoles and the same Grandes Corps tends to reinforce it), as it is found, for example, in the United States.

We can thus explain the level of remuneration of big bosses by the fact that they allocate it to themselves, through their administrators with whom they share the same interests and the same networks. However, if this phenomenon makes it possible to understand the value of remuneration, it does not explain its multiplication since the 1960s. The endogamy of instances of power is as old as the world, and nothing indicates that it is worse today than it was yesterday.

“Wobegon Lake Effect”

To explain the explosion in executive pay, we must therefore invoke a second perverse effect, much more formidable because it is largely counterintuitive.

It was from the 1990s onwards that the regulation progressively imposed the disclosure of the remuneration levels of the directors of listed companies. In the United States, this took the form of a new rule enacted by the Securities and Exchange Commission (SEC) in 1992. In France, it is the law relating to new economic regulations (known as the NRE law) of May 15, 2001, revised by the 1st financial security lawer August 2003, which defined this framework.

In both cases, the objective was the same: to better inform shareholders about executive compensation, with the underlying assumption that if that compensation became public, it would remain contained. However, paradoxically, it was exactly the opposite: it was the disclosure of wages that caused their inflation.

Indeed, once compensation is public, it becomes a measure of the value of leaders and therefore a problem. While it was secret, it did not allow for comparing individuals and therefore remained a purely private matter. Having become public, it imposes itself as the standard of his talent. When a listed company appoints a new director and decides to pay him less than his predecessor, everyone knows it, and we deduce that he is not as capable as the one he replaces. Likewise, if the leader of a company is paid less than the average for his industry, everyone knows this and we will deduce that he is not among the most talented.

It is because remuneration is public that all directors seek to earn more than average and that all boards of directors do not fail to pay them better: a director who publicly doubted the director’s competence would cause the share price to collapse. On the other hand, in order to positively influence shareholder value, a board of directors has an interest in giving all the most patent, measurable and visible signs of the extreme confidence it has in the manager’s exceptional talent: this is what it does when it decides. increase it. Thus, once public, executive compensation becomes instrumentalized both as a measurement tool and as an influence mechanism.

The phenomenon of instrumentalization of the mean is known in the United States as the “Lake Wobegon effect”, named after the fictional town of Lake Wobegon, where, according to legend, “all women are strong, all men are handsome and all children are above average”. If it’s impossible for everyone to be better than the average, the fact that everyone tries to be better than the average causes their inflation.

A recent anomaly

What to remember of all this? In the light of history, the explosion in the remuneration of the bosses of big companies remains an anomaly, and it is a recent anomaly (the French economist Thomas Piketty condemns a “meritocratic extremism”). From a managerial point of view, the current levels of remuneration are not justified, since for a long time companies have been very well managed without their bosses being so well paid.

Furthermore, such pay gaps cause a deep sense of inequality, with a risk of general demotivation, which is far more damaging to company performance than a very hypothetical erosion of executive talent. As American billionaire Warren Buffett slyly puts it: “When a leader with a reputation for excellence encounters an industry with a reputation for difficulty, it is usually the industry that maintains its reputation.”

So if we want to end this historical anomaly that is the explosion in the salaries of big bosses (or movie stars and sports champions), the obvious conclusion is clear: we must keep those salaries secret. Once they are secret, they are no longer a measure of the worth of individuals and therefore a gamble. Of course, nothing says that, by becoming confidential, the remuneration will fall to more reasonable levels (for that, the law would have to impose it or shareholders would have to demand it), but at the very least, they will have less reason to increase.

A major obstacle remains: it is difficult to see how public opinion, scandalized by the current levels of these remunerations, could accept that we decide to hide them. I invite our most pedagogical readers to solve this thorny problem.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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