Why is Executive Compensation Mainly a Concern in the Anglo-Saxon World?

29 May. 2018

Go to Google Trends to search for the term ‘executive compensation’ and you’ll find that users showing most interest in the phenomenon come from the US, Canada, the Philippines, the UK, Australia, South Africa, India, and Germany. In short, from countries which – apart from some obvious exceptions – are predominantly Anglo-Saxon. No other country appeared in the list last year.

More refined analysis reveals that the British and the American media have extensively covered the issue of managerial compensation, focusing not only on the evolution of total compensation but also on its composition. Indeed, the phenomenon has not escaped the attention of the media in continental Europe, although with less intensity. Why is there such a difference in the amount of coverage?

Perhaps the answer lies to some extent with the legal systems of countries such as the US, Canada, and the UK:  the Anglo-Saxon media can count on bigger and juicier scandals than their counterparts in continental Europe.

However, this is not the cause of the higher levels of media attention but rather the result of a confounding factor, a statistical term used to indicate the presence of a phenomenon that explains two other phenomena that misleadingly look as though they’re linked by a causal relation.

To see how the confounding factor concept works, consider a person who concludes that every time the petrol warning light comes on, the car stops. The confounding fact here is the level of gasoline or petrol. The latter causes both the gas light going red and the car stopping.  This third variable is also called a lurking variable.

 

The question is then: what is the lurking variable?

To get to the heart of the issue, we need to examine the structure of the economy and understand how people save.

In continental Europe, banks are at the center of the economy; people bring their savings to banks and banks invest those funds.

On the other hand, in the Anglo-Saxon world, families tend to invest their savings directly in companies, either through investing in ventures or via stocks and shares.

 

Two main implications follow.

 

Implication #1:

In the continental European system, company executives deal mainly with experienced investors such as bankers. From a corporate governance point of view, dealing with fewer investors means less dispersion of shares and thus greater control in the hands of owners and major shareholders.

However, given companies are dealing with experienced investors, it also means there’s less scope room for justifying poor performances.

This implies that managerial compensation is more an issue for Anglo-Saxon countries such as the UK and US where executives are able to get away with under-performance while pushing up compensation levels.

 

Implication #2:

Under the Anglo-Saxon concept of corporate governance, compensation does not include only salary and bonuses but it is the combination of a variety of financial tools. Ideally, workers are paid according to their productivity. This is known as the ‘first best solution’.

When the productivity of a worker is difficult to establish, the ‘second-best solution’ consists of linking workers’ pay to profits via restricted stock, stock options or, bonuses. Hence, if experienced investors such as banks are involved in the executive compensation decision-making process, the productivity of managers is evaluated with greater accuracy and there is less need to attach compensation to the performance of companies.

This helps to explain why restricted stock, bonuses and stock options play a bigger role in the Anglo-Saxon world and less so in continental Europe. It also explains why less attention is paid to the composition of managers’ pay overseas.

Is all the concern about executive compensation then justified?

On the one hand, saving is at the base of the economy structure which determines the way we compensate managers. On the other hand, the capitalist system itself is based on accumulating wealth via savings. If we endanger savings, we weaken our economy. Hence, any abuse of executive or managerial compensation jeopardizes the saving system and therefore weakens the capitalist system.

The Americans and the British likely pay more attention to the issue of compensation for top executives simply because they have more to lose.

 

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Dr. Giuliano Bianchi
About the author

Dr. Giuliano Bianchi is an Assistant Professor of Economics at EHL. He conducts empirical research on forecasting, executive compensation, economics of crime and tourism economics.

Giuliano holds a PhD in Economics from the University of Bologna (Italy), a Master Degree in Economics from the University of Edinburgh (UK), and a Bachelor Degree in Economics from the University of Lugano (Switzerland). Before joining EHL, Giuliano was a Wertheim Fellow at the Labor & Worklife Program, Harvard Law School.

Giuliano’s work has been published in refereed international journals, including Applied Economics and The Quarterly Review of Economics and Finance.

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