Posts Tagged ‘Political economy’
Transaction costs and group action
When you read about executive compensation, or the insane amounts investment bankers are paid, you often hear the refrain that these people can go anywhere in the world for better pay if their country or company dare cut their excessive pay. Even at this time when most of these people are clearly demonstrated to be not worth even a fraction of their bloated pay, you still hear people bleating this crap.
As governments around the world, but in particular in the U.S. and the U.K., contemplate reining in pay in the financial sector, people still cannot let go of this nonsense.
“If one bank holds down pay, then staff will leave and go to one that doesn’t,” said one fund manager. “And if London becomes badly paid then there will be an exodus to Mumbai, Shanghai or Dubai.”
This statement is so patently false, it’s ridiculous that none of the news media challenge the people saying these things. Why is it nonsense? Transaction costs and group action.
Let’s consider the claim that businesses and countries have to keep up with an “international standard of pay” to attract and retain the best talents, who would flee to “Mumbai, Shanghai or Dubai”. If you are talking about someone who is from one of those places, then it is not that hard for them to go back, so that is a credible threat. But consider you are a Londoner, whose foreign excursions are primarily to European resorts for holidays. Are you really going to lightly get on a plane to Mumbai because the pay is better? There is a transaction cost to making such a move.
Anthropologists and sociologists will point out that it takes a certain type of person to make that kind of change, and the average person of any background will not take such a gamble. Those who do will tend to be people more tolerant of risk, which may or may not be a bad thing. (Business commentators will generally say that is a good thing, but the current financial debacle begs to differ.)
Of those who do take the gamble, there will be some who realise after the fact that it was a mistake to make the move. While their old firms may have lost a good talent, the expats are now no longer the competitive threat they may have been.
Even among people who may be going back home, to Shanghai, Mumbai, etc., the case is not as clear cut as you may think. There will be many who left their homes for a reason. A reason why they might prefer not to return. For them the transaction cost of returning home may actually be higher than for a Londoner leaving their homes.
When you consider these parameters, people are more “sticky” than they like to pretend. Then, while firms will undoubtedly lose some talents, you really need to ask some hard questions and perform a cost-benefit analysis to ascertain if the additional cost in higher pay is worth the pay-off. That is ultimately an empirical question, although hard to calculate accurately. My opinion is that it is probably not cost-effective, at least to society as a whole, and probably to long-term shareholders and stakeholders in companies, versus the narrow interests of the bankers and the executives.
Well, what about the threat that you have to pay at least as much as your local competitor? To an extent, that is true. While there are still transaction costs involved with switching jobs, those are much less if your new place of work is just across the street from the old.
The scenario, however, is artificial. Talent is not so narrowly possessed by a chosen few and rarely so spectacularly superior to others that it is necessarily in the interests of a company to be poaching them for high bounties. For example, if you are say an advertising executive who can bring in lots of new business, then it will be worth paying him/her to get that business, up to a point. If an executive can come in and revolutionise your business, it’s worth paying them to come and do that. But these are the exceptions.
Fact is, most firms already have people who are at least adequate to do everything that needs to be done, whether it’s management or sales. So your new-hire is supposed to replace someone and do a better job. But how likely is that?
The company did not hire the original employees thinking they would do a terrible job; they thought the potential hires would be great. What are the chances that the company was wrong the first time, but this time they are going to be right? Especially when they are now paying even more for the new talent?
Fact is, in most cases, unless there is a labour shortage, or a shortage of clearly superior talent, the competitive idea is rubbish. Unless a company is paying its employees significantly less for doing the same job and getting the same results as someone comparable at another firm, there is no reason for the company to keep paying more. There is demand for only so many CEO’s in the world; unless your CEO is a Carlos Ghosn or a Warren Buffett, where will they go? Other companies already have CEO’s; they don’t need yours.
The real reason executive and banker pay is so high is that their pay if often set by themselves or their peers. And when ownership of businesses is spread out so much among shareholders in the stockmarkets, it’s almost impossible for the owners to overcome the difficulties of group action to effect changes.
It can be no coincidence that places such as Germany and France where the stockmarkets are less widely used and developed than in the U.S. and the U.K., and so where corporate ownership tends to be more concentrated, do not appear to suffer from the level of excesses in pay as they do in the U.S. and the U.K.
