Sharing Profits

The Ethics of Remuneration, Tax and Shareholder Returns

J. Reynolds

• Publisher: Palgrave Macmillan
• Year: 2014
• ISBN:
  9781137445452
• Topic: Economics
• Subtopic: Public Finance
• Index: Economics

Any decision by a company regarding the use of profits to pay tax, remuneration or shareholder returns has ethical implications. Sharing Profits reviews high-profile ethical issues facing companies in how profits are used, and proposes a framework for understanding the ethical implications of decisions.

1

Introduction and Summary

Nothing is beneficial that is not also honourable, and nothing is honourable that is not also beneficial ... no greater plague has assailed human life than the fancy of those who have separated the two.

Marcus Tullius Cicero, On Duties

•Any decision regarding tax, remuneration or shareholder returns has ethical implications.

•Standards of business ethics are disappointing and need addressing in order to preserve shareholder value – but these standards reflect ethical issues throughout society.

•Executive remuneration is complex because there is no obvious single correct level or structure.

•A poor CEO can destroy many times more value than their remuneration. Insufficient executive remuneration can create risks for shareholders and companies.

•However, shareholders often feel unrepresented in the negotiation of executive remuneration, with unjustified levels negotiated supposedly on their behalf. While supportive of proper remuneration for the successful executive, there are concerns over instances of an unjustified transfer of shareholder value to executives, notably in the case of payments for failure. An increasing proportion of equity in remuneration will lead in some cases to higher rewards, but in general will also create more disparate outcomes.

•Governments have failed to adapt legislation to match the business environment, notably with regard to the internet and globalisation – using tax as a source of comparative advantage while simultaneously excoriating companies for tax avoidance.

•Businesses and governments are somewhere in the middle of a major process of change in the commercial, financial and political environment. This change in environment has seen a reduction in corporate taxes, and the process of tax reduction may continue, under the pressure of competition in tax rates to attract business, to a minimum level to maintain stability and educate and care for skilled workers. This may challenge aspirations for the welfare state in countries which are not resource rich, notably in northern Europe.

•There have been numerous instances of ethical failings by major companies and the popular conception of company behaviour is often poor.

•Even though ethical principles are difficult to translate into numbers, much of the theory and practice of capital and investment allocation are closely correlated with key ethical principles: notably equality and justice.

•Shareholders are ethically entitled to earn an appropriate risk-adjusted return on investment, provided they do not breach duties to other groups – but these duties need to be understood and accepted. Companies and shareholders benefit from the stability provided by government, especially from limitations on liability. This places a clear ethical obligation on companies.

•Companies cannot effectively address social problems and government policy ambitions themselves, such as addressing income inequality – pushing the onus onto business is occasionally justified, but much more often unjustified, and has to remain with government. The most commonly recognised symbols of income inequality in many deprived areas are often associated with the drugs trade and with celebrities, not with highly paid executives.

•Companies need to adopt clear prioritised ethical frameworks of rights and duties to make informed decisions on how profits are used, and to be transparent about what values are used and how they are implemented.

•In many cases, applying an ethical framework is more likely to help define how a decision should be implemented, rather than necessarily changing the decision. To be meaningful, any ethical framework has to take into account the actions and activities contemplated.

Any decision regarding tax, remuneration or shareholder returns has ethical implications. It is no longer sufficient just to be legal. The unethical today has a risk and a cost in the future. A company, and more precisely its directors, have a duty to its shareholders to maximise its value. It also has duties to other constituencies: to its clients or customers, to its creditors, suppliers and other contractual counterparties, to the government or governments of countries in which it operates, to its employees. Balancing the primary duty to shareholders against other responsibilities is not straightforward. Neither is it purely a financial issue, as decisions have long-term implications (which in turn can impact value). Even from the perspective that the duty to shareholders takes priority above all others, it is important to understand that these duties include managing the risk of harm to shareholder value which could result from causing damage to other groups – such as local communities and employees – and a framework to consider such issues is essential to preserve long-term shareholder value.

The combination of the internet age and globalisation have fundamentally changed the relationship between government and the multinational company. Legislators, governments and international bodies are struggling vainly to catch up. This has profound implications for companies and individuals. Governments are finding difficulty articulating and coping with the resulting challenges, which will fundamentally change the interaction between government and company. Just as the internet changed Main Street/High Street/HauptStrasse before government policy could be adjusted to maintain city centres, so the changes in company structure will threaten the competitiveness and ultimately the survival of longstanding business sectors if governments do not change their attitude to dealing with them.

Managing the relationship and share of profits between shareholders, employees and the state can be complex, and to be done on a clear and informed basis consideration needs to include stated and prioritised ethical rules:

•Shareholders provide capital to businesses, and it is reasonable that they should do so in the expectation that they should be able to earn a reasonable return. There is no large-scale, realistic, alternative model to manage investment and capital allocation for the benefit of society.

•Companies have difficulty in determining how much decision making to refer to shareholders. Although companies may frequently pay insufficient regard to shareholders, at the same time in a major company decision making can be remarkably complex, and even non-executive directors may now find themselves working close to full time.

•It is largely correct to say that the private sector – individual companies and those employed by private companies – fund government.

•In many cases, companies can operate either directly because of government, notably benefiting from “limited liability” on their shareholders and directors, or because they are licensed to extract minerals for example. Government provides stability and services essential to business, such as education.

•Companies have a corresponding duty to support governments. However, the pressure on governments, especially in a democracy, is to appeal to the popular vote. As a result, governments may say one thing, while the impact of their legislation knowingly does something different. In dealing with the state, companies need to – and do – interpret what governments want to see, but at the same time they are aware that the life expectancy of a major company goes beyond normal election cycles.

•Companies have a longer vision than the term of office of many governments. A company’s ethical duties will therefore correspond to supporting government in general, but generally not equate to party political activity.

•The remuneration of executives – especially of a CEO – needs to be relevant to the role, and not risk transferring value at the expense of shareholders. The state is not directly at risk from high remuneration, as personal taxes now generally exceed corporate tax rates, as a largely unacknowledged impact of globalisation.

•Use of ethical codes can be meaningful in both reaching and communicating decisions. Ethics is not so good for providing actual numbers (which ethical groups should accept can be a bit of a limitation regarding issues such as remuneration). These codes need to recognise the most important ethical rights and duties pertaining to a company, and be clear regarding the hierarchy or prioritisation associated with these rules.

There has been widespread and probably increasingly vocal criticism of aspects of corporate behaviour: the remuneration of executives, especially in banking has led to much criticism and in some cases clear shareholder revolts. Credit Suisse pleaded guilty to charges associated with “an extensive and wide-ranging conspiracy to help US taxpayers evade taxes,”¹ agreeing to pay $1.8 billion in fines and restitutions. The tax paid (or not) by various multinational companies has been excoriated by the UK’s Public Accounts Committee. It is important to understand that criticism of tax arrangements is levelled at both new economy companies (such as Google), and old economy (such as Starbucks – coffee shops are a very longstanding form of activity). Despite an unprecedentedly sophisticated and complex remuneration report, a number of investors have either publicly or through voting at its 2014 AGM shown their unwillingness to support incentive pay arrangements within Barclays, a UK-based banking group. Barclays’ incentive pay or bonus pool (to a large group of employees) exceeds dividend payments, which brings into sharp focus both the question of how profits are shared, and how bankers are paid. Specifically, this highlights the difficulty faced by a Board considering a need to invest in mobile intellectual capital, in the form of talented employees, or risk a loss in value, at a time where shareholder returns are modest.

Tax, dividends and bonuses are all paid out of the same pot of money – the profits earned by a company. Companies making decisions regarding one of these payments are by definition affecting the other two. And the interaction between these payments can be surprising, even counter-intuitive. For example, and perhaps ironically, with (much) higher taxes on pay than on corporate profits, the tax authorities are likely to actually lose revenue from lower bonus payments. Tax can be used as one of a number of explicit incentives by governments, including to persuade companies to locate in one particular area (or to relocate from one area to another).

There is a gulf between political posturing and political action, partly reflecting hard economic realities – governments actually need successful companies in order to make their states work financially and socially. It is all well and good to “render unto Caesar,”² but for an international company the competing demands from different tax jurisdictions can equate to more than a company’s entire profits, which rather necessitates an informed debate between the company and the tax authorities, and why can’t Caesar tell us a bit more simply how much he actually wants?

Tax law and international co-operation on tax has struggled unsurprisingly to keep pace with changes resulting from the move of commerce onto the internet, with profound consequences for day-to-day lives, as well as to business models. There is an obligation on governments to maintain tax regulations fairly and consistently. This is difficult, and manifestly an area which is currently problematic, giving rise to some of the problems causing companies to struggle with decisions today. On its own, blaming companies for difficulty in determining how to respond to the inconsistency between tax law and business models is not a fair way for tax authorities to handle this situation. Geopolitics and global trade have changed rapidly in the internet age, and will continue to change, in ways which are unpredictable. The free movement of capital, intellectual property and scope to move operations has contributed to a change in approach in corporation tax. The evolution of taxation may change further, pushing higher burdens on personal taxes, or reducing welfare payments. Companies need to take into account the long-term implications of such pressures for change and the resulting changes, and a conscious ethical dimension to decision making helps protect against decisions which are strictly legal today being seen as actively immoral tomorrow.

Much should and can be done by companies to resolve ethical problems themselves. Ultimately, any attempt to improve the ethical standards of a company, or across business more generally, will only succeed if it is based on inculcating standards across a whole company. Creation of governance committees, more attention on ethics by Boards, more comprehensive codes of conduct, will in the end fail if they do not go throughout the company.

In researching this book, it became clear very quickly that there is widespread cynicism about the motivation of executives, including from groups which would be expected to support them: shareholders and non-executive directors and even Chairmen of major companies. Given this widespread view, there are two different conclusions which could be arrived at: first, that there should be a radical change, or second, that there is no easy radical change. Given that the tendency of investors in large private companies is to offer high rewards, and that high rewards are paid to leading actors, musicians, politicians and lottery winners, it seems difficult to conclude that structures for remunerating executives in quoted companies are simply “broken” rather than being imperfect just because they can result in very high remuneration. In fact, one of the supposed “solutions” to the incentives on banking executives, a group which contributed to the financial crisis, is to pay higher proportions of remuneration in the form of shares. This in itself, in a successful company, will lead to remuneration being higher rather than lower. It will also lead to a randomness in ultimate rewards, with a higher level of divergence in the actual remuneration of executives.

Corporate understanding of ethics is poor, and often left to Board committees, or outside advisers (legal or accounting). Even those organisations attempting to address ethical questions seem sometimes to start from startling positions of ignorance. Advertisements for major companies and public sector institutions seeking to recruit specialists in business ...

Table of contents

• Cover
• Title
• 1  Introduction and Summary
• 2  Greed and Self-Interest? Criticism of Corporate Decisions on Sharing Profits
• 3  Examining the Issues
• 4  Putting Business Ethics into Context
• 5  Applying Business Ethics
• 6  Shareholders and Returns
• 7  Employees and Remuneration
• 8  The State and Tax
• 9  The Rights and Duties of Shareholders, Employees and the State
• 10  Ethical Frameworks and Case Studies
• Postscript
• Glossary
• Notes
• Bibliography
• Index