Why High Pay is Bad for Capitalism

05/28/2010 05:12 am ET Updated May 25, 2011

Too often, capitalism's strongest supporters defend high executive pay, especially in the finance sector, in the belief that they are upholding the principles of the free market. This is a grave mistake. The market for pay has been distorted by self-interest, and the capitalist system they hold dear is suffering as a consequence.

Since the 2008 financial crisis, much attention has focussed on how to ensure that large bonuses do not encourage employees to take excessive risks with investors' money. But there is another, more deeply entrenched problem -- one that has passed without serious challenge, but may pose an even greater long-term danger to capitalism. That is the abuse of the term "talent" when describing senior corporate executives or finance sector employees.

These people, we are told, possess such rare commercial talent that they can rightfully lay claim to fabulous wealth. This view persists despite the absence of any reasonable method of measuring individual performance, let alone attributing a company's financial success to it.

The myth of rare talent is propagated and relentlessly championed not just by the high earners themselves, but also by many others who stand to gain from it -- their headhunters, business schools and management consultancies that sell their services to company chiefs, and the senior employees of institutional shareholders who benefit financially from the exact same myth.

Those who promote the "talent" argument repeatedly evoke an erroneous comparison with sports stars. Many people may object to the high earnings of the latter on moral grounds, but it is certainly rational to pay for sporting prowess that is highly transparent, and close to irreplaceable. Only a handful among the billions on the planet could emulate the skills and impact of Alex Rodriguez or Lionel Messi.

By contrast, the success of a company may have little or nothing to do with the alleged abilities of its most prominent employees. Benign economic conditions, a powerful and long-established brand, a lack of industry competition, smart middle managers, or just plain luck, to name but a few factors, may have had a greater influence on corporate success. It is especially difficult to pinpoint executive influence in firms that employ tens of thousands of staff worldwide.

Even if the impact of senior corporate executives was indeed measurable, what precisely is it that they do that a significant number of other diplomatic, articulate, persuasive, insightful, credible, energetic people with related experience couldn't also do, given the right mentoring? Not everyone has what it takes, of course, but surely enough do to create sufficient competition for those top jobs. Or are we really to believe that the only people with commercial talent are the tall, white, middle-aged men who dominate Western boardrooms?

Similarly, the supposed rare talents of super-rich employee bankers have not been adequately explained. An ability to sell, while reasonably uncommon, is hardly limited to a tiny proportion, especially as it is a skill that can be transferred across sectors, once supplemented with some product training. Some bankers have undoubtedly mastered complex financial products. But aren't there sufficient numbers of university graduates in esoteric subjects to suggest that many more people are capable of mastering complexity?

The truth is that the "talent" referred to in the workplace does not generally describe a rare ability, as it does in sport. Rather, it is duplicitously deployed to defend the positions and wealth of high-fliers in a knowledge-based economy, where the value of individual contribution is so subjective. In doing so, it serves to sanction the unwarranted plunder of shareholder funds.

In the modern world, those shareholder funds mostly belong to the population at large, through their pensions and savings. Opinion polls reveal that while American people have no problem with entrepreneurs becoming extremely wealthy, they smell a giant rat in the form of high corporate pay. The growing realisation that a small club of insiders has stolen the system from them has created a widespread popular resentment, making democratic governments more prone to heavy-handed measures that stunt growth. The brazen appropriation of wealth also discredits the entire system of free enterprise.

There are other damaging consequences of the talent myth. Excessive pay at the top of our public companies distorts the incentives for smart, hardworking people away from entrepreneurship, with all the creative energy and innovation it unleashes, and towards a life of office politics and ladder-climbing, working in jobs that many others could also do.

Of course, not everyone weighs up whether to work in a large company or go it alone. It would be hard to imagine the likes of Bill Gates or Steve Jobs patiently making their way up a company hierarchy; likewise, many people will always prefer the relative security of a decent salary.

But there also exists a substantial group of people who, while not natural risk-takers, are nevertheless driven to succeed, and dream of the independence that wealth brings. For them, the choice is clear. On the one hand, they can find a gap in a competitive market, raise start-up capital (perhaps mortgaging the family home), hire staff and crack the bureaucracy, all the while knowing that their business might well fail. On the other hand, they can play the corporate game, earning enough for a comfortable lifestyle on the way up, with a massive risk-free pot of gold on offer if they reach the top.

The former course may seem more romantic, but the latter is difficult to resist. Extremely high pay, often perceived as a symbol of capitalist success, is in reality a major impediment to its success. The talent myth that sustains such excess must be confronted.

David Bolchover (www.davidbolchover.com) is the author of "Pay Check: Are Top Earners Really Worth It?" (Coptic Publishing).