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Are Shareholders to Blame for Executive Greed?

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Howls of outrage here in the UK, where Sir Fred Goodwin, former head of the Royal Bank of Scotland (RBS) is to receive a pension of £703,000 a year. This is despite the fact that he is widely regarded to have brought the bank to its knees through an ill-advised merger with ABN-AMRO in 2007.

Sir Fred will have plenty of time to enjoy his pension, as he’s only 50 years old and is apparently in good health. His former employer, however, is in a slightly more precarious state, having been taken over by the government to prevent it collapsing in October last year. This has led to accusations that such generous pension arrangements are essentially “reward for failure,” with suggestions in some corners that the government, as majority shareholder, should simply refuse to pay.

As the global financial crisis had deepened and the number of business failures and bail-outs grows, there has also been a rise in the number of commentators professing shock at the rewards reaped by former captains of industry, and accusations that it is their greed that caused all these problems in the first place. What nobody seems to have done is question the motives of shareholders to whom these executives are answerable.

The premise is simple. Shareholders in a company will want it to remain profitable so that they can continue collecting dividend payments. As these payments are made on a regular basis, executives are therefore encouraged to look for strategies that will give their share price a boost in the short term, rather than planning several years ahead. After all, if the shareholders are unhappy with their performance, they could be forced out.

The effect of this while the market was rising was that shareholders were happy to unquestioningly sign off on ever-higher salaries and bonuses for executives, provided those dividend cheques kept rolling in. The executives, able to reap the rewards for short-term measures had absolutely no incentive to plan for the future. And as trading in exotic financial instruments brought what appeared to be bigger and better profits, so they were actually incentivised to take more risks, rather than aim for steady growth.

Will Sir Fred Goodwin have his pension confiscated, as some speculate? It’s unlikely, given how watertight employment contracts at that level tend to be. Will he be villified? Most definitely. But as those shareholders who have seen the value of their holdings dwindle away to virtually zero lick their wounds, they might also like to ask themselves why they were not more worried about the behaviour of executives years ago.

[Image by Steve Wampler]

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