A rotten corporate culture

Reports by select committees of MPs after some scandal should be treated with care. There is nothing MPs like more than to take the moral high ground and heap blame on others in front of TV cameras, whether their victims deserve it or not. But in the case of the collapse of Carillion, their condemnation of the senior management, the board and the auditor seem fully justified. When the Institute of Directors say that “effective governance was lacking at Carillion” you know things were very wrong.

Think of the company as a ship. The captain has steered the ship too close to the rocks, and seeing the impending disaster has flown off in the ship’s helicopter and with all the cash he could find. After the boat hit the rocks no lives were lost, but many of the passengers had a terrifying ordeal in the water and many lost possessions, and the crew lost their jobs. Now if this had happened to a real ship you would expect the captain to be in jail stripped of any ill gotten gains. But because this ship is a corporation its captains are free and keep all their salary and bonuses. The Board and auditors which should have done something to correct the ship’s disastrous course also suffer no loss.

To say this reflects everything that is wrong with neoliberalism is I think too imprecise. [1] I also think focusing on the fact that Carillion was a company built around public sector contracts misses the point. (I discussed this aspect in an earlier post.) To say, as the MPs do, that the collapse of Carillion is the result of recklessness, hubris and greed tells us nothing, because many people are bound to be those things if the system provides no incentives for better behaviour. The problem is that the senior managers, the auditors and the Board are not in prison and have not even suffered any financial loss.

In theory the incentive for better behaviour is that everyone except the auditors have lost their job and are unlikely to get another. But executive salaries are now so high that this penalty, if it is applied, is just not strong enough. The former chief executive, who resigned in 2017, earned £1.5m in 2016. (A third of that was in the form of a bonus that could have been clawed back until the remuneration committee made that more difficult in 2016.) Few people would think that never being able to captain a ship again was a sufficient disincentive for the imaginary captain who steered his boat too close to the rocks.

The idea from Econ 101 that CEOs are paid their marginal product is now laughable. Their pay is so high in part because it is set by cosy remuneration committees, but mainly because CEOs have considerable bargaining power over the firm that employs them. This power is intrinsic, so greater oversight by shareholders will do little to change this situation. I wrote some time back that perhaps economists should think about the benefits of a maximum wage, or a return to punitive taxation on CEO type salaries and bonuses. [2] That idea normally provokes shock and horror, but have economists come up with a better idea to offset this market failure at the centre of modern corporations?

As far as auditors are concerned, there is much talk of breaking up the big four. The idea is that in a more competitive auditor environment there would be more opportunity for firms to establish a reputation, and for those that failed to do so to go out of business. I suspect the issues go deeper than that. It would be interesting to know if existing auditors after a high profile failure like Carillion lost market share. It may be that shareholders have insufficient power to ensure the selection of auditors useful for them. If that is the case, there may be a case for giving regulators greater power to act on shareholders behalf.

Ultimately corporate failures are a reflection of how companies are governed. I tend to agree with Will Hutton that the model where the shareholder and more particularly the share price are king is deeply flawed. The term financialisation is a bit like neoliberalism in that it is used by different people to mean different things, but I think it does describe how corporate culture has changed in the UK and US (at least) over the last few decades. We must never forget that the largest disaster in recent times reflecting a rotten corporate culture was the Global Financial Crisis.

Will writes

“My contention is that limited-liability companies, having certain formal privileges and status, should not be the private playthings of transient owners interested only in their own immediate self-enrichment, without any concern for how their profits are made. They should be organisational structures that allow humanity to innovate and then produce to meet the great challenges of any era: in this context profits are made by delivering a noble, moral business purpose, integral to the wider legitimacy of the enterprise.”

The big challenge is to work out the most efficient way of achieving that goal.

[1] What I think is fair to say is that a neoliberal culture is why attempts to address these problems have been ignored for so long. Ed Miliband talked about predatory corporate practices, and the overwhelming reaction was that this made him ‘anti-business’ and ‘too left wing’.

[2] The idea currently being embraced by politicians is to publish firm pay ratios: the ratio of the CEO’s pay to the average employee in that firm. You could cap that as a policy, although it is not obvious to me why CEO’s in firms (in sectors like finance) that have highly paid employees should be allowed to expropriate more from the firm than those with lowly paid employees. However as this is not my area, I am happy to see analysis on the optimal way of removing this distortion within corporations.