City comment: Shareholders must speak for capitalism

Something has gone wrong with capitalism. That remark was made to me recently not by a Marxist agitator but by a former Tory minister — one who also happens to have a long and successful track record in business.

It’s not something he would have said a generation ago, when he was in the vanguard of the Thatcherite revolution. But when he says it now, wise heads of all political persuasions nod in troubled agreement. The calibration of the great machine that drives free-world economies has gone out of sync, and it’s not easy to see how it can be fixed.

What my friend meant more precisely was that the rewards of capitalism have gone haywire: they are no longer distributed in ways which are economically optimal or, to most people’s thinking, socially fair.

First, there has been a swing in the balance between investors who provide capital and the managers of businesses which use that capital.

Last week’s stock-market falls, taking the FTSE 100 back to levels first reached 15 years ago, are a reminder of how feeble returns have been in most sectors since the turn of the Millennium. Yet during that same period, median earnings of senior executives of FTSE 100 companies have soared by 278%, according to a new survey by Income Data Services.

Institutional shareholders, it must be said, have been inarticulate in resisting this trend.

They rarely bother to vote against executive pay awards; they express dissatisfaction over low returns either by demanding changes in management or by churning portfolios in search of better yields elsewhere. Few think of themselves, in the Warren Buffett mode, as committed, long-term partners in the businesses concerned.

This changed relationship favours short termism over sensible business planning and investment, including the research and development that’s essential to remaining globally competitive. Meanwhile, revolving-door hiring and firing fuels the executive-pay spiral, encouraging higher demands in compensation for lack of security.

But if shareholders ought to be well capable of exercising their rights and looking after themselves, there is another shift in the balance of rewards that is even more perturbing.

Directors of FTSE 100 companies now earn 120 times the average pay of their employees, according to IDS, compared to 47 times in 2000.

That reflects a pendulum swing since the late 1970s, when the multiple was only about 20 times and undervalued British executives were generally demoralized as a result. It also reflects the globalisation of companies in the index, including mining giants whose workforces in Africa and elsewhere typically earn very little.

But it’s striking that in a period when average UK earnings have been rising at less than 1% per annum — and real wages, adjusted for inflation, stand below where they were in 2008 — executive pay rose by more than a fifth in the past year.

The justification offered is that corporate chiefs operate in a global talent market (telecoms and media businesses top the pay league, even ahead of banks) and that ambitious companies have to offer top dollar to attract the best.