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Matthew Hancock MP: For markets to work properly, we need a change of culture at the top of big companies

Hancock Matthew MPMatthew Hancock is MP for West Suffolk and co-author of "Masters of Nothing".

The free market is the most powerful force for prosperity in the world. The fast-growing nations that we used to call the emerging markets are living testament in our times to its power. Over just two decades, billions of people have connected to the global economy for the first time, and their prosperity is catching up, fast. I grew up in a small business. I know from very personal experience the pressures on businesses, and how businesses create valuable products and jobs.

As well as being a practical force for good, the free market embodies some of our most important values as a society. Foremost among these is fairness: the idea that people should be rewarded in proportion to the effort they put in and the value they create.

These principles are connected. For markets to work, they need strong frameworks – a strong rule of law, for example – to ensure that effort is fairly rewarded.

So when this principle of fairness is subverted I, as a Conservative, get worried. If the free market is seen to be unfair, then a dangerous credence is given to the arguments of the anti-business left. The pressure grows on governments to bow to the popular mood by imposing the wrong sort of regulation.

Yesterday’s report by the Income Data Services (IDS) on executive pay will inflict further damage on capitalism’s battered reputation. It reveals that across the FTSE 100 total directors’ pay rose by an average of 49% this year, to £2.7 million. Bonus payments for directors are 23% higher than in 2010. By contrast, the average private sector workers’ pay settlement rose by just 2.6%.

Yet over the last twenty months the FTSE 100 index has gained no ground at all. In fact, FTSE 100 share prices have barely changed since 1998. In financial services the picture becomes even more distorted once you factor in the implicit state subsidy which results from being ‘too big to fail’.

Society has no problem with generous executive pay, provided the executive is seen to create value. Think of the many tributes paid to the brilliant leadership of Steve Jobs, who died worth an estimated $7 billion. No-one criticised his pay because in earning it he had improved so many peoples' lives (he types, on his iPhone). Unfortunately for FTSE 100 directors, it is hard to find the enterprise or the value creation to justify the pay: the awards reflect neither higher dividends for shareholders, nor increased revenues for the Treasury.

How do we address this problem? All too often, debates about business ethics degenerate into an argument about the need for more or less regulation. But the financial crisis proves that thinking in terms of quantity is unhelpful. We have seen the wrong sort of regulation in spades. The number of pages in the FSA rulebook increased from 2,730 to 9,283 between the dot-com bubble in 2001 and the collapse of Lehman Brothers in 2008. Yet we are told RBS obeyed every one of these rules before it collapsed in the biggest banking crash the world has ever seen, and its boss was left with a monstrous pension.

Instead the answer is designing the system correctly. Regulation must set the rules of the game: emphasise individual responsibility over blind box-ticking, and ensure markets are competitive, break down monopolies, and ensure the shareholders can effectively hold the executive to account.

Of course, in theory, shareholders – the owners – have the power to run companies. But in practice they fail to get a grip. The very human reasons for this can be found by understanding human psychology – in which institutional shareholders, acting as agents, cover their own backs, and don’t stick their neck out at an AGM.

This calls for a change of culture at the top of our big companies, which too often act as bureaucracies, not as enterprises. It means tackling corporate governance, rewards for failure, and conflicts of interest which proliferate on remuneration committees. The evidence even shows that more female participation at the top of big companies changes behaviour too.

For those of us who believe in the power of capitalism, we must face the challenge posed by the popular horror at escalating pay at the top. We must change the culture to save the very free markets on which our prosperity depends.


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