Switzerland: Riding the management storm

Calls for stricter regulation of management salaries are raised in the context of the banking crisis, Myriam Käser writes for ISN Security Watch.

Management salaries have been the subject of public debate for years. However, the current banking crisis has put the issue on top of Switzerland's political agenda. The Swiss government has bailed out external pageUBS, the world's largest manager of private wealth assets, with CHF 68 billion. As a result, hundreds of demonstrators protested against rip-off salaries last Thursday in Zurich's city center and blocked the entrance of the UBS building.

Over the weekend, the major Swiss parties discussed the issue at their respective party conventions. The external pageSocial Democratic Party criticized the government's aid package and called for an upper salary limit.

In the spirit of personal responsibility, the liberal external pageFree Democratic Party (FDP) claimed that UBS managers should pay back their bonuses. At the same time, the party fully supported the government's rescue package.

Bonuses were also the focal discussion point of the external pageChristian Democratic People's Party. The party's president postulated no bonuses were to be paid to top management and the board of directors as long as the government was financially engaged in UBS.

Exorbitant salaries and economic efficiency

One thing is to ask is whether double-digit million CHF yearly salaries and so-called CEO-to-Worker-pay-Ratios of over 300 are normatively justifiable.

"They are problematic in terms of distributive justice and manager's integrity," Ulrich Thielemann, vice director of the Institute for Business Ethics at the University of St Gallen, told ISN Security Watch.

However, another more contemporary question is whether such payments are economically efficient. From an economic perspective, high salaries are not problematic provided that they are the result of a functioning market. But there is no consent in scientific literature about whether the market for managers functions efficiently. Equally disputed are the reasons for the worldwide rise of management salaries.

For some, steeply rising salaries imply insufficient corporate governance of big corporations where managers can largely define their own salaries at the expense of the shareholders. For others, they are simply the result of higher demand for top managers. Both positions can be reasonably defended but none can be proved. This is partly due to the fact that the financial success of a company depends on many factors management cannot control. Furthermore, management's contribution to a company's success can not be empirically determined. This means that it is also not possible to objectively define the adequate salary.

How to set the right incentives?

It is commonly agreed that direct regulation of compensation - such as fiscal discrimination of higher salaries or legally defined maximum salaries - leads to distortion and hence economic costs. Such regulation can also adversely affect the attractiveness of an investment location.

The situation looks different however, if the incentive system in place in the end results in the taxpayer having to make up for a bank's failure. In such a situation, the state can legitimately claim to have a say in the design of a company's incentive structure.

These incentives should prevent management from overestimating chances while underrating risks. They should facilitate the long-term success of a company that is not always in line with the short-term interest of the individual actor.

More power to the shareholders

Earlier this year, Swiss entrepreneur Thomas Minder submitted the initiative "external pageAgainst Rip-off Salaries" to the Federal Chancellery in Berne. The initiative forbids termination pays, advance payments and bonuses in the event of company sales. It further demands that shareholders of Swiss-listed companies must validate the total of all remunerations of the board of directors and of management on an annual basis.

To give shareholders some decision-making authority in this regard is an economically sound policy.

Minder emphasizes his commitment to the free market economy and entrepreneurship: "To let shareholders decide about the individual pay checks of managers would be too big of an interference."

For the same reason, Minder does not advocate a limitation of salaries the way Germany recently defined it for its stranded banks.

"We are the only country where shareholders have no say whatsoever in this regard," Minder complains. Other countries such as Australia or the Netherlands already have a system in place that gives shareholders more decision-making authority.

Minder's initiative finds supporters across political affiliations. The Swiss Federal Council is currently discussing management compensation in the stock company law. In light of the financial crisis, the Council reached the conclusion that shareholders' rights must be strengthened. According to the Council, it should be easier in the future to reclaim bonuses in case of obvious failure.

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