How much am I worth: DNA October 13, 2010

Irony seldom escapes the characters on the economic stage; and when the issue pertains to one’s own well-being, Adam Smith’s free market self-interest or Ayn Rand’s virtue of selfishness prevails.

And why not, since we all want to partake a portion of the wealth of success. It was not a long time back that the prime minister asked private sector honchos to be abstemious in their remuneration. Now, all the MPs have gone ahead and given themselves a rise in their salaries.

When Lehman became a euphemism for the greed that the private sector represents, government officials ascended the high horse to say how they were different and that the private sector stinks when it comes to remuneration. Now, we have the RBI as well as the public sector banks arguing for parity with the private sector. What is one to make of it considering that each segment thinks that it deserves the hike and, as a corollary, the others don’t?

The extremes in salaries are stark. US Fed chairman Ben Bernanke takes home $200,000 per annum while European Central Bank president Jean-Claude Trichet earns $500,000.

Bank of England chief Mervyn King has package of $450,000 while Japan’s Masaaki Shirakawa is paid $400,000. Our own RBI governor Duvvuri Subbarao gets the rupee equivalent of around $30,000. In contrast, in 2009 Goldman Sachs was reported to have had a wage bill of $16.2 billion for 32,500 workers, giving an average of $498,246 — half a million dollars per head!

Clearly, the regulated take home larger pay cheques than the regulators, though the latter admittedly have greater powers. The question is how are salaries to be fixed?

In a free economy, salaries should be the function of the owners or shareholders. If it is the private sector, it is the proprietor or the shareholders. This holds just like it does for, say, a household where it determines the salary to be paid to the maid or watchman or driver. However, structures are amorphous here.

Most big companies have shareholders and even an owner-driven company may not really have a majority. Salaries are fixed by the owner on the premise that the majority has voted for it but the majority never really gets together to take a decision and hence the process of salary determination remains fuzzy.

At times it ends up with the owner, who is the management, also appointing the board which ratifies one’s own salary.

This should be treated as an internal affair but it becomes a public concern if bailouts have to be invoked when things go awry. The crisis did not stop at the financial sector, where public money was involved, but also overflowed into manufacturing, which then brought to the fore the issue of executive pay.

When it comes to the government, it is even more complicated. There are hierarchies where a bank chief is at the level of a secretary and one cannot go up without the other doing so. Hence, either all salaries have to move up, or all stagnate. The public sector enterprises are better placed even though there is government ownership, as here the CEOs get better pay packets, which can range between Rs30-40 lakh per annum, though this is still lower than that in the private sector.

Now, there is a strong case for salary revisions in the public sector banks, especially when they perform as well as those in the private sector. But there is a conundrum. A just way of going about it is to increase all salaries by x%.

This is democratic but allows free riders to benefit. It is actually the middle and senior levels where personnel can move to the private sector quite easily and the threat of attrition is real. There are a number of IAS officials who have gotten lucrative deals in the private sector to become heads of commodity exchanges or infrastructure companies. A number of private banks took in public sector officials and have grown really well.

However, does an executive, who is two years away from retirement, deserve a private sector salary? Yes, if the organisation is doing as well as its private counterpart. Critics aver that there are few public sector employees who find jobs after they retire. Salary hikes are needed to prevent attrition and the present system of backdoor increases through the recruitment of consultants with fixed tenures is not sustainable.

The solution is really to leave it open to the companies or banks to decide their pay packets which should be linked to profitability. This will create a problem for the bureaucrats as there is no profit and the incentives must be linked with performance in terms of expense management or implementation of projects.

As a corollary, the grades should be delinked from the bureaucracy charts. This would also mean that banks must have their own system of picking their CEOs with the ministry being out of the picture. This is the only way to make it work and should hence be looked at holistically.