First published in the Financial Times on 8th April 2014.
I am unimpressed by executives who earn millions but invest little in their own business
There are few more inflammatory topics than the issue of what people earn. Yet there are profound misunderstandings, misguided envy and ignorance at the heart of this personal yet economically vital issue.
For the vast majority of people, the concept of earnings means an annual salary. But this is not how most wealth is accumulated by individuals. That happens through capital gains, or asset appreciation. Very few become seriously rich via salary: first, in many countries it is taxed relatively highly (at a marginal rate of almost 50 per cent in Britain, including payroll tax), and, second, because most of us find it hard to save money from our monthly pay.
Part of the issue is semantics. Even expert commentators mix up the words income, wages, salary and earnings. Perhaps to all intents and purposes they have interchangeable meanings now. But in many respects they are not the measure that matters – whether for motivation, economic impact, or knowing who actually amasses fortunes.
The media and the public focus on the salaries of “fat cat” directors of public companies. This is because these figures are disclosed and hence easy to discover: finding out how wealth is otherwise obtained is generally much harder and almost no media organisations have the resources nowadays to undertake that sort of research. While salaries of top business bosses are frequently excessive, they are not really where the big money is made.
For example, in the London property world, the directors of the institutional landlords such as British Land or Land Securities are typically worth chicken feed compared to the proprietors of the dozens of family companies that own hundreds of millions of pounds worth of property, much of it notionally held offshore.
Meanwhile, I am not convinced large salaries are that effective in delivering superior results – but it seems the City and stock market feel they are essential. I think paying a chief executive 100 or even 200 times the basic pay of the lowest-paid worker in a company is both ineffective and bad for capitalism. CEOs at FTSE 100 firms in Britain receive an average of £4.5m a year including bonuses, pensions and options – as well as all sorts of other perks. But it almost appears as if banking advisers and fund managers encourage the excess. Let me explain.
I am exploring the idea of taking one of my companies public: as part of the preparations, experts were brought in to benchmark the CEO and finance director salaries against comparable executives in similar publicly traded firms. Their report suggested possible immediate pay increases of as much as 200 per cent. They failed to realise that my partners in this venture are co-owners, not employees. That is the private equity model – and partly why so much talent had defected from public markets to do buyouts.
Ultimately, when I look at a public company annual report, I rarely get worked up about how much the board are paid: what interests me is how much stock they own. I am deeply underwhelmed by executives who earn millions but have very little invested in their own business’s shares. If they have such modest confidence in the enterprise they actually run full time, then why should I?
Receiving benefit in the form of an ultimate capital gain – as opposed to a regular, predictable sum of cash every month – is deferred gratification incarnate. Building a commercial concern as a founder – rather than a hired member of staff – is a risky undertaking and, in my experience, takes years before it really pays off. Often it involves a net loss rather than a profit. So any gain is highly uncertain, both in terms of amount and timing. Moreover, such entrepreneurial initiatives create most net new jobs. It makes sense for the state to encourage individuals to chance their livelihood by trying to grow a business – which is why almost all countries tax long-term gains at lower rates than income.
Globalisation and easy money from central banks have fuelled share and property inflation. At least while those trends continue, ambitious individuals should concentrate on the principle of being a principal – rather than obsessing about the one- dimensional subject of salary.