by Mike Soden
The angle you might take in this discussion on compensation can depend on what your starting point is. Are you a self-made entrepreneur who has never asked nor would ever ask for assistance from society, a professional person who is independent minded and has a fee-earning capacity, or a public servant who serves our society but who might view the fairness of our world through different social lenses?
With the construction boom we experienced an employment boom which in turn fed a tax intake boom, culminating in a government spending boom. Between 2004 and 2008, the public sector grew from 270,000 employees to 320,000, an increase greater than the total employment in the banking system in Ireland, which had grown over a couple of hundred years. The incremental cost of these 50,000 additional employees, including pensions, would be close to €2.5 billion a year.21 Who is responsible for this cost? We know the public service and its masters did not consider the consequences, but we can be sure it is the taxpayer who will pay.
People who choose to dedicate their lives to public service have an inbred belief that they are entitled to be treated in a certain way. In fact, in almost every sector of society we have burdened ourselves with the concept of entitlement. This sense of entitlement never diminishes but keeps pace with the growth of the economy. Should the economy fail to grow, the reality of dealing with the shortfall is dismissed in favour of borrowing more to pay for yesterday’s foolish decisions. In contrast, the salaries of those in the private sector adjust upwards and downwards as a consequence of their own efforts and the good or bad fortune of the marketplace.
For people to believe they are entitled to a risk-free lifestyle with an income to match, followed by a secure pension, seems to be stretching the boundaries of fairness and reasonableness in society. In a competitive world we may not be entitled to anything other than the right to earn and to be treated with respect. Our Government is there to strike a balance for our community and it must find the strength to tell us all when we have spent too much and, in turn, to reduce our incomes. If this means that the welfare payments that have seen progressive increases over the past ten years need to be reduced, then so be it. This would not be inconsistent with the cuts and increased taxes that are being experienced by us all. The Government can no longer go to the international markets to borrow what is required to fill the deficit unless they are seen to be making inroads into reducing this deficit. It may take one or two generations to get back to where we were at the peak of the boom. We have an obligation to pass on to the next generation a country in better shape than that which we inherited. I imagine that, despite our efforts, whatever we pass on to the up-and-coming generation of young adults may not meet their expectations.
During a period when every level of authority would appear to have let society down, those who provide a strong ethical and moral backbone through the public service are facing losses that they were not prepared for. The natural reaction to reject government proposals in various parts of the public sector could easily be mistaken for petulance when in fact it was a reaction to brute force and ignorance in the communication process. The reaction of offended parties will always be more favourable if they are dealt with openly and honestly. What this might lead to in the public service is a prolonged disruption to services which might well have been avoided by clearer dialogue. The void that has appeared in the management of the public sector is easily filled by unions who wish to take care of their people. Whoever is paying the wages and salaries of this sector should be strong enough to exercise their responsibility as managers of their staff. No one wishes to take a step backwards in compensation, particularly if you have not contributed to the downturn; however, it is simply unfair that benchmarking is a one-directional mechanism that does not adjust to negative growth in the economy.
Compelling reading and viewing it may be, but as the dirty laundry of the elite bankers and developers in Ireland is hung out to dry in public, the question arises as to whether the excesses of these executives are excesses in the context of the industry or only in the eyes of the public. How do people, intelligent directors, arrive at the conclusion as to how executives are to be compensated for their work? The dimensions of the executive jobs are easily measured and can be compared to similar jobs in similar markets. For bankers at a certain level, it is inevitably one of the great joys to read the headlines in the newspapers announcing increased profits, and increases in earnings per share and in dividends, and to hear forecasts on future expansion and growth, perhaps in the form of international acquisitions. The skills and experience required to deliver future growth are recognised in the form of salaries,bonuses, stock options, pension contributions and so on. Like the rich list, there is a list of highest-paid corporate officers and, on examination, nothing seems extraordinary. At least not if you happen to be on the list.
In countries that seek social fairness the highest salary is considered in terms of being a multiple of the lowest or average wage. This multiple varies from industry to industry and country to country. In Holland, the salary received by the highest paid executive is four times the average wage, the lowest multiplier in Europe. This multiplier can be in the hundreds in different sectors and countries. These differences between average and top earnings can be explained by executives who believe that the payments they receive are consistent with the value brought by them to their shareholders. In my view, executives get rewarded for creating returns on the capital provided by shareholders, whether this is based on a riskfree or a highly speculative strategy.
Most shareholders in Ireland have holdings either directly or indirectly in the banks. Over the years, no matter what the performance of the institution was, it was difficult for many of these small shareholders to understand how anyone could be worth the enormous annual compensation awarded. The market is real and competition exists, and so remuneration committees, with outside help from compensation specialists, agree a contract with the executives. One might ask whether the interests of the executives should be in line with the shareholders to ensure that a conflict of interest does not exist. Experience suggests that synchronizing the objectives of both parties leads to improved performance and growth. A return on capital is often viewed by the shareholders and the boards to be the best yardstick for performance. In financial institutions, because the amount of capital required is substantial and this capital in turn is leveraged highly, the returns on capital have tended to be high historically. If executives have the opportunity of earning large rewards for their efforts, the assumption is that the salary paid is not merely for turning up at work each day. Paying people to manage these complex businesses for success carries an implied contract of reward. The implied contract is that this payment is to ensure that satisfactory performance is achieved. The definition of satisfactory is laid out by the board and arrangements are put in place to compensate for better than satisfactory performance. Performance will frequently include the achievement of both short- and long-term goals. The problem is that if the institution fails to meet its growth targets and anticipated return on equity, the executives normally pay a high price for failure: the loss of their jobs in most developed countries, not necessarily in Ireland. What other occupations in the private sector can put a country at risk through poor performance?
As taxpayers, we have discovered to our expense that systemic risk is real and creates, financially, the single largest moral hazard. If banks don’t examine the total framework of risk under which they operate, the directors are either inadequate for the challenge or are careless in the belief that they will be bailed out. The built-up frustration of the public and small shareholders is palpable. How can those who have overseen the destruction of such wealth continue in their employment and be paid such outrageous amounts?
The solutions to the banking crisis and its fallout being bandied about among the chattering classes seem to have a strong socialist underpinning. I lived in Norway for several years in the late 1970s and early 1980s. On one occasion the Vice-chairman of Ci
ticorp/Citibank visited Oslo. He mentioned that he did not fully understand the basis of socialism in the Scandinavian countries. So, at a meeting with the Governor of the Central Bank of Norway he enquired as to the practical meaning of the egalitarian concept. He asked if it would it be right to assume that if a citizen had two houses and his neighbour had none, he would keep one and give the other to his neighbour. The Governor replied, ‘Quite rightly, yes.’
‘And’, continued the Vice-chairman, ‘if you had two cars and your neighbour had none, you would keep one and give your neighbour the other?’
‘Rightly so,’ said the Governor.
‘And what about if you had two shirts and your neighbour had none, would you give him one of your shirts?’
‘Definitely not,’ said the Governor.
‘Why?’ asked the Vice-chairman.
‘I have two shirts,’ replied the Governor.
The moral to the story is that it is always easy to give away something that you do not have.
As the crisis develops we hear the cry ‘Let the rich pay!’ resonate in the press, on TV and in general conversation everywhere, the assumption being that the rich are not the ones who have already paid the price. After all, who else can pay at the end of the day? The revenue authorities may determine that those with income in excess of €160,000 per annum are designated as wealthy while those with assets in excess of €1 million are rich; however, we live in a community where the definition of wealthy is unlikely to be recognised by those who are in that category. Such families may in reality struggle with a tight cash flow since they must account for unexpected increases in household expenses, school fees and insurance, not to mention the predicament of negative equity. We must remember that those people who have created wealth over time are the ones who, more than anyone else, have contributed to the growth and prosperity of this country. The country needs and should encourage wealth creators. With respect to the taxation and welfare systems in the country, the increased welfare benefits that are enjoyed today mostly come from the contributions from the higher paid through capital gains tax, stamp duty and increased income tax. The tax system is driven by a need to fill the coffers to pay for the unending social welfare and public sector demands that exist and may appear to many of us as excessive.
While we are spilling over with frustration and the need to find retribution for the national economic crisis, we have to take a look at ourselves in the mirror. We can point fingers and wag tongues about the banks, the developers, the regulators, but what of the Government? The same party has been re-elected for three consecutive terms. They were not put there by the opposition but by the electorate. If we wish to vent our frustration then perhaps we should question our own judgment as we got what we voted for – an example of the price of freedom of choice. This can only raise the question as to the skill sets, experience and leadership attributes that are required by government ministers and whether some new processes should be put in place in the selection of those charged with the responsibility of leading our country.
It is foolish to suggest that rich people are just lucky when in fact most of them have one thing in common – their focus on wealth creation. Take a person who has appeared on a rich list – unless this person has inherited their fortune or married well (and divorced better), we can assume that he or she has earned the money. In turn, they would have converted some of these earnings into savings and then into investments. While luck is an element in wealth creation, it is intelligence, analysis and good judgment that underpin the retention and growth of one’s capital base. You are unlikely to last the pace and retain your wealth if you are not a good risk manager. The awareness of the risks has to be matched by astute decision making.
It could be true to say that society admires and respects those who amass great fortunes, while it begrudges or scorns those who are on the lower steps of the wealth creation ladder who are endeavouring to succeed financially. Do people who succeed really care about what society thinks about them? People who have actively amassed wealth have usually had a willing partner at the right time. For some of Ireland’s wealthy that was the multiplier effect of leverage, which they now know is a good servant but a very bad master. We go through continuous economic cycles and it is experience that enables wealthy people to remain so in the face of adverse downturns. For instance, the wise reduce their debts at the first signs of a downturn to enable them to take advantage of an upturn when it comes. Borrowing is the lifeblood of business and capital growth, but it is having the flexibility and judgment to reduce one’s exposure at the right time that can mean the difference between success and failure. Leverage needs to be actively controlled within the parameters of good risk management.
Whatever can be gleaned from reviewing a rich list, whether it is national (Ireland or the UK), European or in a non-geographic category, there is sufficient evidence to suggest that employees of big institutions, unless privately owned by the founders, are unlikely to be on any rich list. So, where does most of the wealth go that is created by successful companies? To the shareholders, who are invariably large pension funds that redistribute these gains to their members. Shareholders want the leaders of companies to have that internal compass that directs their organisations to growth. Often senior business people can find it difficult to grasp the difference between their money and that of the shareholders. One might interpret the attitudes of some business leaders as ‘What is good for me is good for my shareholders’, which is, of course, putting the cart before the horse. As an employee, you are a servant of the shareholder and not the other way around.
There is a real case to be made for the right of people to desire to become rich. Using the instrument of leverage, whether in the property, stock or commodity markets, people sought to create personal wealth through investment over the past fifteen years. Blaming people for being ambitious or greedy is a waste of time and the cry for an egalitarian system is likely to fall on deaf ears. Our capitalist system may appear damaged but it is unlikely to be replaced. It will, however, be modified as the animal spirits of the market continue to be tamed somewhat by the regulators. Capitalism, like democracy, has its flaws. However, the critics of capitalism might discover that all other systems are worse.
During a time when shortages are prevalent in most areas of society, it is intriguing to browse through the lists of plenty. Understanding that the commercial retail distribution sector dominates the rich lists in Ireland, Europe and the US might help one in determining where to invest or begin a career. The property sector is represented principally by those activities where there are cash flows attached to the businesses with a strong likelihood of these flows remaining. The entertainment sector has a number of notables but only a handful of artists achieve status in financial as well as artistic terms. Oil and technology are two sectors that have given rise to wealth for enterprising and innovative people.
In the end, the creation of personal wealth comes from innovation, energy, capital and a good business plan. Capital gains are recognised by the taxman as the necessary incentive for people to create wealth through risk taking, as the tax rates are structured to benefit the entrepreneur. Wealth creation requires commitment; there is no time for sleeping as trading in investments takes full-time attention. We should recognise and celebrate the success of individuals who have improved their lot in life through their focus and energy, and some good fortune. These people have contributed more than most to the tax take in this country, and the state’s coffers require a lot more of them to reduce the fiscal deficit.
National economic recovery is about the creation of wealth. Confidence, trust and liquidity are the three main ingredients for success. As the downturn slowly levels out personal wealth across the country, we will need a new generation of wealth creators to come forward. It can be argued that the NAMA gamble is very much a shared risk with the taxpayer and, if successful, only has the potential to be credited with wealth recovery and not wealth creation. It could al
so be said that, if NAMA succeeds, it will be a feather in the Government’s cap; if it fails, all of us will feel the effects.
CHAPTER 5
Recovery – Returning to Normal
There is no returning to normal. There will be a new normal which will come about by our acceptance of economic reality. Mindsets of entitlement and great expectations should be altered according to the new economic circumstances. Getting the nation to accept the cuts and losses over the next five years will be a stern test for the Government. The Government can only borrow so much and the tax take over the foreseeable future is unlikely to return to what it was at the peak of the boom.
When we talk about the weather in this country our choice of terminology always amuses me. We don’t appear to have hurricanes or tornadoes but we do have storm force winds that are capable of taking the roofs off houses, preventing aircraft from taking off or landing, sinking ships or causing the devastation of centuries-old magnificent forests. Politically it is not a good thing to admit that you were in power when the greatest fall in economic terms was recorded. However, surely when we have experienced an 11.3 per cent fall in GDP in one year,22 which would be enough to make anyone depressed, it would be more appropriate to label our circumstances as a depression rather than a ‘deep recession’. If silent dissent is the unwritten rule for boards, perhaps it has filtered into the political and media arena also. Facing up to reality might well make the electorate, the public service, the unions and the private sector come to grips with the severity of our problems. Recognising where we are and clearly defining where we wish to be within a specified time frame will give us all the sense of achievement we deserve when better times arrive. And they will arrive.
