The Hindu Business Line : Of corporate pay and ostentatious living

There is a need for more transparency so that the shareholders and the public have a better knowledge of the compensation packages of company brass and their relatives.

Alok Ray

The Prime Minister, Dr Manmohan Singh, is considered somewhat different from the typical Indian politician. For one, even his worst critic would concede that he lives a simple life. So, perhaps, he has the right to chide others for vulgar consumerism.

Recently, he asked the industrialists assembled at the Confederation of Indian Industry (CII) for restraint on corporate pay and for desisting from the public display of ostentation. In other words, the Prime Minister had asked the rich, famous and powerful to consider the larger social consequences of their consumption patterns. Is he justified in his comments?

As for the compensation packages offered to CEOs, the standard argument is that corporate pay is market-determined and, hence, supportable in terms of efficiency and productivity. In other words, people with major responsibilities need to be incentivised to perform well.

The trouble with this argument is that, in many cases, the market that determines the pay of CEOs is rigged. In theory, the shareholders, or the ‘owners’ of the company, decide the pay of the CEO. But, in practice, it is the boards of directors that determines their pay packagethe CEO. Most board members are usually directors of several companies; thus, they have a vested interest in keeping the pay high as they themselves would benefit.Representative directors from the government or the financial institutions usually would not question the decisions as in many cases they derive indirect benefits by keeping company bosses in good humour. And to this exclusive club, the usual HR (human resource) rules obviously do not apply. Indeed, many CEOs not only award themselves handsomely but also create lucrative severance packages, called golden parachutes.

Not the right picture

The protagonists of high management pay point to empirical evidence that, in India, the salaries of chairmen and managing directors of family-run outfits have grown at a less faster rate than the growth in the value of the company shares. But this does not prove much. First, there has been a share market boom in India, largely fuelled by surging foreign funds flow and India’s promising growth story. The efficiency of the CEO may have little to do with that trend.

Second, many CEOs and their kin have large stake in their companies. Hence, their salaries may not increase at the same rate as the price of the company’s shares, but they benefit as shareholders when share prices rise. Hence, looking merely at the salariesof CEOs does not give the right picture of the growth of their total benefit package.

If the market for determining the pay of company executives is not competitive enough, the issue is: How much differential in pay between the ordinary worker and the CEO is needed to produce the incentives for risk-taking and successful running of companies? The multiple of the difference between the lowest and the highest paid in a company is many times more in the US than in Europe. This probably explains the greater dynamism of the American companies. There are many successful European companies just as there are cases of failing US companies that are being bought out by entrepreneurs from other countries. So, industry needs to do some introspection.

This is not to suggest that the bureaucrats should fix the pay of private sector company bosses. However, there is need for more transparency and disclosure requirements so that the shareholders and the public have a better knowledge of the compensation packages of company bosses and their relatives. It is not enough to play fair. In a democracy, it is equally important to create an impression in public mind that the rules of fairplay are being followed. Next is the more general question: How much inequality is justified in the larger interests of society? Most will agree that inequality serves a social purpose if the rich earn their wealth by honest effort (not merely by inheritance) and they invest their savings in further expansion of production and employment. No doubt, flaunting wealth in conspicuous consumption will create more demand (for luxury goods), production and jobs (even for ordinary workers of all kinds through the so-called multiplier effect), but it may also breed greater social discontent. There is another situation where inequality does not create revulsion. That is when even the poor feel that they too can make it. It then becomes an incentive for effort, rather than an inducement to destroy the system.

A real-life anecdote is instructive here. One of my colleagues was teaching at a US university. One cold winter night he was coming back from his office. The street was deserted. He suddenly saw a vagabond moving towards him, and was a little afraid that he would be mugged. The man, however, approached him and told him in a patronising voice: “You seem to be a sincere student. I did not make it. Work hard, you will make it.”

My friend, who had also spent some time in the former Soviet Union, wondered: “How come this man, who has not got anything from the US system, still believes that one can make it by hard work, whereas the common people in the USSR, who got much from the system, believed that the system did not work for them?” This faith has allowed the American system to survive while the Soviet way collapsed.

Losing faith

Possibly, the Prime Minister wanted industry to ensure that the people do not lose faith in the Indian system. However, what he did not mention is that much of the blame for people losing faith in the system should go to the politicians and bureaucrats, rather than to industrialists or celebrities. For example, most poor people enjoy the spectacle of a lavish Bollywood wedding as it provides an escape from the hard realities of their daily life.

Even the Naxalites do not agitate against the wealth of the Ambanis or the Premjis. They are more concerned with land rights, jobs and wages, not the CEO pay package. People get disappointed with the system when their sick child dies without getting treatment at a government hospital or the police do not register a case against the politically powerful. The industrialists are not responsible for this state of affairs and even the semi-literate public knows it well.

(The author is a former Professor of Economics, Indian Institute of Management - Calcutta. He can be reached at alokray15@yahoo.com)

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