I think I agree with Richard Murphy . I feel faint. He suggests removing tax relief on salaries above a certain level. I think he means that when taxable profits are calculated, those salaries will not be counted as costs and subtracted from revenues, so will be taxed twice, once as profit and once via income tax. That will make it much more expensive for shareholders to employ high-paid staff. He suggested basing the salary ceiling on median earnings; I’d suggest tying it to the minimum wage.
The old economic model of wage determination is that workers are paid their marginal product. If hiring the worker will add £X to your bottom line, it makes sense to pay them up to £X and if the labour market is competitive, £X is what they will be paid .
Imagine that top salaries were capped at £250,000. Now imagine the sort of person you’d be able to hire to run your bank for that wage. How much more productive is the sort of person currently being hired for an average of $9.7m? My guess is: not enough to justify the salary. Under the proposed scheme, salaries would not be capped, but the cost to shareholders of paying salaries above a certain level would increase.
A more recent economic model of wage determination is to suppose that the combination of workers and capital in a firm generates a surplus, and workers and shareholders bargain over that surplus. The surplus generated by a bank or a multinational is breathtakingly enormous. My contention is that the bargaining power of top executives is so strong, and the surplus up for grabs so large, that salaries have completely cut loose from any idea of marginal product and represent a market failure that anybody who thinks of themselves economically minded can not justify.
I’m going to make ad hoc appeals to irrationality that will alienate any of the aforementioned economically minded. It’s no mystery how top executives pay themselves that much – they run the show – the mystery is why shareholders don’t discipline them. Shareholders worry about share prices falling. If the cost of disciplining executives who are looting the company is higher than the reward, they won’t do it.
For whatever reason, the idea exists that “leaders” of “global calibre” are a valuable asset to a firm . Now, say you are a major shareholder who thinks this is bullshit and wants to contest pay deals. First, merely the disruption and uncertainty might knock the share price enough to make it better just to pay the swine their millions. Second, if your supposed global leaders do go off in a huff, which they very well may if you are moving unilaterally, your share price may take a really big hit. So it doesn’t happen .
I think the only thing restraining executive pay is the benchmark of other executives’ pay – what is the going rate? This is a multiple equilibrium situation . I don’t know what governs the evolution of the going rate, but I don’t think it’s the marginal product of “global leaders”.
To make concrete just how skewed the cost benefit picture is for shareholders wanting to restrain executive pay, if you own 10% of a £1bn market capitalization company, then cutting executive salaries by a whopping £10m could add £1m to your annual dividend. You lose £1m if your shares fall just 1% per cent. This is why shareholder activism on executive pay is rare. I suppose a corollary of this is that Richard’s proposal, which will merely increase the cost of high pay to shareholders, may have little effect. [paragraph somewhat edited, see comments]
Of course, if shareholders of every corporation cooperated and agreed to pay no more than £X, global leaders would have to take £X or leave the game. This is why I am attracted to legislation that acts as a coordinating device to correct this market failure. Ideally high pay legislation is something that would happen globally, but I hope that the UK has a sufficient quantity of high ability individuals who would be prepared to work for a few hundred thousand pounds a year (peanuts!) that it is something we could do on our own.
Here’s a puzzle. According to most political economists, what motivates politicians is getting elected. My guess is this policy would produce howls of anguish from certain quarters, praise from the bien pensant lefties at those crucial Islington dinner parties, and be a smash hit at the ballot box. What’s stopping Labour?
Update! Tim Worstall informs me that something similar to this idea has been enacted in the USA since the days of Bill Clinton. If true, this suggests two things: 1. It doesn’t restrain high pay and 2. it is politically feasible and firms will not decamp overseas.
 With the proviso that I expect people to point out pragmatic reasons why what he proposes wouldn’t be feasible – most likely to do with creative lawyers and accountants cooking up other ways for company directors to make out like bandits. That, and every large UK company would instantly relocate its head office overseas. I use the world salary here: I mean to include any method of remuneration including payment in shares.
 This is a useful start, but a few moments thought tells you there must be more to it than that. For example, with certain production functions, say when people have to work as teams, the concept of the marginal product of a single worker is not meaningful.
 Possibly because it’s true, but I doubt it. This is my appeal to irrationality – I’m saying a false belief is prevalent amongst investors.
 Investors (shareholders) also rely on good relations with management. If rocking the boat results in being denied some
insider tidbits guidance from management, it’s not worth it.
 The “bargaining over surplus” model supports multiple equilibria, within boundaries set by the size of the surplus and the participation constraints of the parties involved (so what matters is the “outside option” – if any party can do better elsewhere, they’ll leave). Nobody has a very good theory of where, within this feasible set, the outcome will lie.