Getting shareholders more involved in compensation arrangements is a big goal of corporate governance reform types. In fact, the failure of proposals now before Congress to get shareholders more involved forms the core of objections coming from people like New York Times columnist Gretchen Morgenson. But whatever the problems might be with Congress assigning bureaucrats to evaluate pay, they pale in comparison with attempts to get shareholders more involved.
Despite what many think, few shareholders have a subjective interest in executive compensation at the companies whose shares they own, except during extreme cases of corporate failure or truly shocking pay packages. One sign of this is that when given the opportunity, shareholders rarely act to reduce pay or enact rules that would give them a ‘say on pay.’
Why don’t shareholders care more? Shareholder apathy is completely rational because diversified shareholders lack an incentive to become overly familiar with the operations of individual companies. They own a diversified portfolio of investments, so their interest lies in a prosperous economy and a rising stock market rather than the governance of individual corporations. They rationally care about the big picture rather than the compensation of individual executives.
This means that shareholders would likely do a poor job of evaluating pay packages. They lack the knowledge of the market for executives, and don’t have a reliable metric for recognising compensation practices that encourage overly risky actions. This ignorance applies to both individual shareholders and institutional shareholders. Individuals are too busy with the rest of their lives to become better informed, and instituions are specialists at portfolio management rather than corporate governance or executive pay.
What’s worse, ignorant and apathetic shareholders will not actually control the debate on executive pay. Instead, the debate will be dominated by committed special interests. The rational ignorance and apathy of ordinary investors produces the entirely predictable effect of rendering them vulnerable to special interest exploitation. Agency costs of self-serving managers are a now familiar example of this. And because of our long-standing familiarity with managerial agency costs, we’ve developed various corporate structures, reward incentives and legal frameworks aimed at better aligning investors and managers.
Less familiar—and therefore more dangerous—is exploitation by groups of shareholders who have interests that diverge from ordinary shareholders. Investors lack experience in fending off the self-serving activities of these groups, and there are few legal constraints on their activities.
labour unions are the primary example of these would-be exploitative special interest groups. Through their pension funds, labour unions are empowered with enormous financial leverage over companies even now. Any proposal getting shareholders more involved in executive pay would have the unintended consequence of allowing unions to tie their labour negotiations to proposals for executive pay. The predictable result of this would be a transfer of wealth away from ordinary investors, as union leaders and executives cut self-serving deals with each other.
This isn’t to say that nothing can or should be done about executive pay. But it would be far better to take small steps, at the level of the states or individual corporations, than pass nationwide mandates that will be hard to reverse and whose costs will be hard to detect.
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