Debate Over Executive Pay Heats Up in Europe

Accent on égalité: Europe loses patience with its wealthy elite
By John Thornhill, Richard Milne and Michael Steen
Financial Times, 9 June 2008

When Wendelin Wiedeking, chief executive of the Porsche sports car company, became Europe’s highest-paid businessman last year by earning an estimated €67m, the head of a rival German carmaker shook his head in disgust. “Everyone has the right to earn decent money. But €67m? That is obscene. It goes against every principle of social equality we have,” the chief executive said. “I just cannot understand how he can justify earning so much more than the normal worker.”

If even Europe’s top bosses are criticising their colleagues’ pay then something, it seems, has gone awry with capitalism. Over the past few months, denunciations of boardroom excesses have risen to ear-splitting levels, with politicians across Europe amplifying a mood of popular disgust.

Horst Köhler, Germany’s president, recently described global financial markets as a “monster” that must be put back in its place, criticising the “bizarrely high” pay of some financial managers. Jean-Claude Juncker, Luxembourg’s prime minister and president of the “eurogroup” of eurozone finance ministers, has denounced excessive executive pay as a “scourge”. Nicolas Sarkozy, France’s president, (pictured above) has criticised “rogue directors” and has been calling for a “re-moralisation” of capitalism. It is perfectly acceptable for successful, job-creating entrepreneurs to earn a lot of money, he has argued, but it is quite wrong when failed managers and job-destroying speculators reap the same rewards.

An FT/Harris opinion poll survey published last month found that strong majorities in five big European Union countries considered that the gap between rich and poor had grown too wide. Majorities in the UK, France, Italy, Spain, and Germany supported tax increases for the wealthy and tax cuts for the poor.

At a time when ordinary workers are suffering the consequences of an economic slowdown and a surge in food and energy prices, it is shocking to many people to see how top executive pay continues to defy economic gravity. Why, they ask, should this super-class of bankers and chief executives be rewarded so exorbitantly?

According to a study published last month by L’Expansion, the French business magazine, the collective pay of the CAC-40 bosses leapt by 58 per cent in 2007, inflated by the exercise of stock options. French politicians have been outbidding each other in expressing their outrage at the pay levels of France’s big bosses and demanding public intervention.

Christine Lagarde, France’s finance minister, said it was scandalous that some chief executives had received massive payments irrespective of achievement. Warning of a possible public backlash, she called on France’s biggest bosses to rethink how much they paid themselves. “If this is not the case then one fears that under public pressure rules, laws and European directives will intervene,” she said.

Some European governments are already taking action to curb boardroom excesses. One of the first laws Mr Sarkozy passed on entering office last year was to force companies to be more transparent about “golden parachutes” paid to departing executives and to link them to their performance while in their posts. The French president had previously condemned the €29m ($46m, £23m) paid to Daniel Bernard, chief executive of Carrefour, when he was ousted from the French retailing group in 2004.

In Germany, the Social Democratic party, part of the coalition government, is pushing for legislation to curb excessive corporate pay, though this is not yet official government policy. SPD legislators are demanding two things: that companies’ supervisory boards, which include trade union representatives, take over responsibility for executive remuneration from special compensation committees; and that “excessive” pay be no longer deductible from a company’s taxable profits.

The debate has perhaps gone furthest in the Netherlands, which even by European standards has strong egalitarian traditions. Two big pay-outs to chief executives who left their companies after foreign takeovers have drawn particularly sharp criticism. Jan Bennink, chief executive of Numico, left with nearly €80m in stock options, shares and bonuses after the food group was bought by Danone. Rijkman Groenink, chief executive at ABN Amro, stepped down from the underperforming Dutch bank with €26m in options and share awards following its contentious break-up by a consortium of foreign banks.

In response, Wouter Bos, finance minister, has drafted legislation, currently being considered by parliament, that would tax such payments more heavily. Under the proposals, a company would pay 30 per cent tax on any golden parachutes worth more than an annual salary for executives earning more than €500,000 a year. Pension contributions on such high salaries would also be taxed more heavily.

It is not just governments that have been moved to action. Investors too have been flexing their muscles in recent months, notably on bonuses that are not linked to an individual’s performance. Shareholder activist groups have also condemned golden parachutes, labelling them as “bonuses for failure”. In March, shareholders in Philips voted down a proposal at the Dutch electronic company’s annual meeting to remove performance conditions from grants of share options. Last month, Shell shareholders expressed dissatisfaction with a plan to award three executives bonuses of €1m. The motion was carried but just under half of voting shareholders failed to back it and a third voted against.

Many European executives appear shaken by the rhetoric directed against them. But, by and large, they remain unapologetic. For example, Mr Wiedeking says his pay is fully justified: when he took charge of Porsche in 1993 the company was on the verge of bankruptcy. Now it is the world’s most profitable carmaker with an operating margin last year of 80 per cent (though this is mostly due to derivatives trading rather than selling cars). “I think when the company does well then those who have contributed should share in that,” he says, pointing to a rising share price and increased bonuses for workers.

Even companies renowned for their concern for workers’ welfare such as Bosch, Europe’s largest privately-owned industrial group, are conducting a counter-offensive. Acknowledging that the public debate has soured, Franz Fehrenbach, chief executive, suggests business leaders must do a better job of explaining themselves. “The higher income earners pay a majority of taxes and that is absolutely OK but they shouldn’t be cursed for it. Business has become the bogeyman,” he says, adding: “The whole discussion in the country is a danger. When we as managers let ourselves be described as asocial there is an issue.”

Alex Wynaendts, the new chief executive of Aegon, the Dutch insurance group, says that some recent excessive pay-outs have not been right but suggests that the furore surrounding the issue has been overblown. “It seems to me there’s something of a competition about who’s being most aggressive on this for electoral and political purposes,” he says.

Although it is hardly a popular argument, some economists defend the high levels of executive pay – as well as the principle of golden parachutes, even for failed managers. Intervention to redress the supposed wrongs of the marketplace could prove counter-productive, they argue, driving away talent and rendering the whole market for executive pay more opaque.

Augustin Landier, assistant professor of finance at New York University, says that chief executives’ pay has generally increased in line with the value of the companies they run. “With globalisation we have seen the size of companies increase dramatically. Even if you think that a CEO can increase the value of a firm by 0.001 per cent it is still a big order of magnitude,” he says. “You do not have to believe that these guys are geniuses for their compensation packages to make sense. You want to pay for the best.”

Mr Landier claims that golden parachutes can also encourage executives to reveal – rather than conceal – mistakes to the ultimate benefit of shareholders. “In an industry like banking it is really costly to delay the release of information. The economic rationale of golden parachutes is that it gives chief executives an incentive to release negative information when they realise something wrong has happened. It also speeds up the replacement of CEOs by making them willing to leave.”

He suspects that the outrage about excessive boardroom pay will die down as executives see their compensation fall next year as a result of the economic slowdown and politicians realise the difficulties of writing effective legislation.

If, however, the public clamour persists, some executives suggest there will be an increasing flow of talent from Europe to the US and from publicly-quoted companies into lower-profile private equity funds.

Wolfgang Bernhard, a manager who was tipped for stardom in the car industry after leading roles at Daimler and Volkswagen, became fed up with media scrutiny and has become an adviser to Cerberus, the private equity firm that bought Chrysler in the US. “He wanted to work without reading about his name every day in the paper and everybody analysing his every motive from pay to a desire to cut costs,” says a close friend.

The backlash against income inequality is not confined to Europe. The FT/Harris poll found that respondents in the US, China and – to a lesser extent – Japan were worried about the gap between rich and poor. This is perhaps unsurprising given that in many countries, globalisation’s gains have benefited the owners of capital disproportionately over the past decade – as seen in the split of national income between capital and labour (see chart).

The paradox is that, in spite of the furore over boardroom extravagance, pay gaps in western Europe remain among the lowest in the world. A 61-country income study, conducted by Hay Group, found that the gap between the salaries of senior managers and clerical workers in the region were among the most compressed.

Moreover, it seems the public in Europe has little faith that politicians, for all their rhetoric, will redress the income imbalance. In the FT/Harris poll, few respondents (5 per cent or less in all five major European countries) believed the income gap would narrow over the next five years.

Politicians may well tinker with executive pay at the margins and rethink ways of redressing income inequality. Shareholder pressure may also shame some corporate managers into slightly more moderation. But the era of hypercapitalism, as it has been called in France, is unlikely to fade away soon.

Copyright The Financial Times Limited 2008