Bonus systems encourage and reward a focus on short-term gains at the expense of the bigger, long-term picture.
We know that bankers’ bonuses and an unhealthy focus on the short term played a part in the financial crisis. But is the reality much worse than that? Has the bonus culture infected public companies in general and led to the dearth of business investment that is holding back economic recovery in the UK and the US?
Economist Andrew Smithers certainly believes so. In his new book The Road to Recovery, he argues that a 20-year trend towards rewarding senior management with bonuses has profoundly changed the way big companies are run. Instead of investing for the future, they are incentivised to get both profits and the share price up in the short term by raising prices, making acquisitions, increasing dividend payouts and instigating share buybacks.
As a result, they avoid the risks of investing for the long term and the challenge of establishing the company in new markets. Incumbent management will be long gone by the time the existing strategy blows up.
The result is that levels of business investment have fallen with a corresponding impact on the pace of economic recovery. As with most theories, the analysis is easier than the policy formation and implementation. To reverse this situation, governments would have to interfere big time in the running of private sector companies and especially on the thorny issue of executive pay.
Until the crisis, the standard government argument was that remuneration in private sector companies was a matter for their shareholders. Even in the aftermath of the financial crisis, there has been a reluctance to be too prescriptive on bankers’ remuneration and the UK Treasury is currently challenging new EU bonus rules in the European Court.
The reason shareholders do not control executive pay is partly because they are not organised to do so but, more particularly, because they also prefer short-term rewards over long-term investment. They are happy to feast on dividend payouts and buybacks that push up share prices and increase their returns. So maybe it would be better if more companies remained unlisted?
Again, governments in most countries are firmly committed to the idea that listing companies is a good idea and, if they do not have a full array of exchanges for small companies, they are busy putting them in place. It would take a fundamental rethink to embrace the idea that unquoted, owner-held companies could ever hold sway over listed ones with their broad distribution of shares.
And perhaps there is an even more profound problem – the decline of the corporate citizen for which no offsetting legislation is really possible. Where managers have a sense of their own historic role in passing on their company in good working order to the next generation, as well as revering it as a national symbol, they tend to take long-term decisions to the best of their ability.
Unfortunately in many countries – the UK and the US would be leading examples – these values disappeared long ago and very little can be done in terms of legislation to reverse the tide.
