According to the High Pay Commission’s final report last week, the average FTSE 100 chief executive now takes home £4.2m in annual pay. That’s 145 times the salary of their average employee and an increase of 4000 percent over 1979. By contrast the ratio between top and average was 20 times or less 30 years ago, since when average pay has risen by just 300 per cent. On present trends by 2020 the multiple will hit 214 times.

Is there any management justification for paying people who run large established companies, which by and large grow at about the same rate as the economy, such enormous sums of money? No, not one.

• No reputable study has shown a link between executive pay and performance: in fact the evidence challenging the existence of a link ‘has become increasingly compelling’.
• There is however plenty of evidence of the damage done by stratospheric pay to the fabric and cohesion of the company. There is a whole page of references in the report to the importance of employee engagement to performance (and see my piece here). The single most important thing companies can do to boost performance is to improve dismal engagement levels by managing people as if they mattered. Enormous pay inequality says in the starkest fashion that people don’t matter. And the inequalities continue to rise. Last year alone FTSE directors’ pay went up a stunning 49 per cent at a time when many at the bottom of the scale were taking pay (and pension) cuts.
• ‘The [national] economic case for getting to grips with the dramatic escalation of top pay is increasingly apparent. Extreme levels of pay inequality have a [negative] impact on: entrepreneurialism; growth; economic instability; sectoral imbalances; social mobility.’
• The idea that exorbitant pay reflects a ‘market rate’ is a myth. As the report makes clear, there is no functioning international market for top executives – if there were, real pay would be the same everywhere. A ratchet is not the same thing as a market.
• Finally, paying people according to different criteria fails the tests of both fairness and simple logic. If high pay is essential to induce some people to get out of bed in the morning, why should it be different for those at the other end of the scale?

As with dreadful people management, there is almost complete consensus that excessive management pay is destructive, scandalous, and shouldn’t happen. So, again as with people management, the only interesting question is – what is causing it that makes it impossible to stop?

The answer is, governance.

There’s no point in wringing hands over it: soaring executive pay is not an aberration. It’s the logical creation and consequence of a corporate governance structure that is enshrined in all our City codes. The HPC is only half right to say that pay excess ‘is a symptom of a particular form of free-market capitalism’: more accurately, it is its triumph.

Unfortunately, the HPC does not peel back that ‘form of free-market capitalism’. It was born in Chicago with Milton Friedman and his associates. Crucially, it was transmitted from macro to micro economics by Professors Michael Jensen and William Meckling, who in 1976 published a celebrated paper in the Journal of Financial Economics entitled ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure‘.

As Roger Martin recounts in his important Fixing the Game, Jensen and Meckling’s is the most quoted article in economics history. It is also the most influential. It is not much of an exaggeration to say that one academic article has shaped the course of corporate history for the last four decades.

It has much to answer for.

Management based on it, says Martin, ‘has reduced shareholder value, created misplaced and ill-advised incentives, generated inauthenticity in our executives, and introduced parasitic market players. The moral authority of business diminishes with each passing year, as customers, employees, and average citizens grow increasingly appalled by the behavior of business and the seeming greed of its leaders. At the same time, the period between market meltdowns is shrinking. Capital markets – and the whole of the American capitalist system – hang in the balance.’

Along the way, it has given us a new caste – the imperial, and imperially paid, CEO.

As Steve Denning noted in a recent Forbes post, Jensen and Meckling performed the time-honoured trick of creating an artificial problem to which they just happened to have a handy solution. The straw man was the ‘agency problem’: the supposed misalignment of ‘principals’ – the firm’s shareholders – and their ‘agents’ – managers and workers, who left to themselves were allegedly spending more energy tending their own interests than those of their shareholder-principals.

For there to be an agency problem to solve, two crucial assumptions have to be made. One is that the company’s sole purpose is to maximise value for shareholders. But why should shareholders be singled out as ‘principals’, their interests privileged above other company stakeholders? To justify that, Jensen and Meckling had to make another heroic assumption – that shareholders own companies.

That belief is now so engrained that it has become invisible; the assumptions, at least in the Anglo-US context, have become fact. But it is a myth.

Here’s what two business professors wrote about it in that fiery left-wing organ Harvard Business Review last year. ‘It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes – even when a loss in value is documented–courts side with directors the vast majority of the time’.

Here’s the late Sumantra Ghoshal in a much admired article in Academy of Management Learning and Education: ‘We know that shareholders do not own the company… They merely own a right to the residual cash flows of the company, which is not at all the same thing… They have no ownership rights on the actual assets or businesses of the company which are owned by the company itself, as a “legal person”. Indeed, it is this fundamental separation between ownership of stocks and ownership of the assets, resources and the associated liabilities of a company that distinguishes public corporations from proprietorships or partnerships. The notion of actual ownership of the company is simply not compatible with the responsibility-avoidance of “limited liability”.

Here’s Paddy Ireland in another frequently quoted article, ‘Company law and the Myth of Shareholder Ownership’: ‘Disinterested and uninvolved in management, and, in any case, largely stripped (in law as well as in economic reality) of genuine corporate ownership rights, the shareholder is, as Berle and Means pointed out, ‘not dissimilar in kind from the bondholder or lender of money’. While, therefore, the relationship between shareholder and company is not exactly one of lender to borrower – the share is not, as some have suggested, a kind of loan – neither is it in any meaningful sense one of owner to owned’.

And finally (although plenty more could be added) Charles Handy: ‘The idea that companies are owned by shareholders is, excuse me, balls. It is the cause of all kinds of problems… Somehow the myth has grown up that shareholders are owners; whereas the law says that the corporation is an individual and therefore has the same legal and moral obligations as a person. Even more than that, a company is a community, a group of companions, which means that it can’t be owned by anybody else in any real sense. You can own the village, but not the inhabitants in it – we used to call that slavery’.

If companies aren’t owned by shareholders, the whole governance edifice on which executive pay is the culminating spire simply collapses. The agency problem vanishes. The single-minded imperative to maximise shareholder value vaporises too, and with it the requirement to incentivise managers to achieve it. In fact, such incentives can now be seen in their true light, as destroyers of corporate cohesion and engagement and thus squarely contrary to the board’s fiduciary dury to the company itself.

It has been forgotten, including alas by the HPC, that agency theory and governance based on it (including all our City codes) come out of assumptions grounded in ideology, not in any evidence of what actually ‘works’. As Ghoshal pointed out they have no predictive value, and none of the current governance prescriptions have any correlation with superior performance.

In fact the contrary: one of the revelations of Martin’s book is that, extraordinarily enough, shareholders have done less well in the past three decades of shareholder primacy than they did in the postwar years when managers were supposedly ripping them off.

One of the crowning ironies is that the Jensen-Meckling theory was at bottom anti-management: it was framed as a response to managers’ self-interested ability to exploit their corporate position for their own ends. Yet the greatest beneficiaries of the resulting new order have been managers who first accepted, then eagerly demanded as their entitlement the escalating alignment incentives on offer – including managers and fund managers of institutional shareholders, themselves benefiting the same self-serving incentives. This unholy alliance has hijacked all the corporate returns during the period. While profits on both sides of the Atlantic soar to record heights, it is only managers, both corporate and finance, who have benefited.

Present corporate governance arrangements not only did nothing to prevent the crash of 2008: they helped cause it. As with executive pay, they, and the assumptions they are based on, are the problem, and any solution that uses them as the starting point will self-evidently fail. It’s no use asking shareholders to discipline managers, because they are playing on the same side. That helps explain why no attempt to rein in top pay has had the slightest effect so far.

Unfortunately, as the HPC report shows, the fact that these ideas are time-expired does not prevent them exerting a powerful influence from beyond the grave. The Commission will apparently continue to work for another year after delivering its final report. Before it disbands, it should make it its job to put a final stake through the zombie’s dark heart – otherwise its prescriptions, for all that many of them are right, will suffer a similar fate.

The only conceivable response to the research about worker engagement and company performance is: ‘duh’. Come on, wouldn’t you expect a happy workforce to be more productive than a unhappy one? Engaged and secure staff more likely to go the extra mile for the boss and the customer than bitter and twisted ones who are scared of losing their jobs? And isn’t it common sense that that would pay off in better business performance?

Yes in each case: and you’d be right. Although it is hard to be categorical about what causes what, the evidence is that high employee engagement and satisfaction is indeed reflected in superior business outcomes, including profit. Among a stack of similar studies, the most recent scholarly research finds that a value-weighted portfolio of the ‘100 Best Companies to Work for in America’ outperformed the market average by a cheerful 3.5% a year over 25 years – hardly a flash in the pan.

Nor is there any mystery about what causes people to enjoy their jobs and work at them. Things like responsibility for doing a worthwhile job, work autonomy, opportunities for personal growth, working with good colleagues and recognition head the list. Salary and working conditions – another ‘duh’ – rate barely a mention. They are ‘hygiene factors’, demotivating people when inadequate but never becoming a positive source of satisfaction, however high they go.

Yawn. Tell us something new.

Yet the commonplaces contain a large puzzle.

Because the ‘alpha’ garnered by companies that put employees first shouldn’t exist. It resembles the economists’ hypothetical £5 notes that really are lying around in the street because no one has picked them up. Think about it. We know that overall, global levels of employee engagement are dismally low, the proportion of those highly engaged plunging downwards from 20 per cent in the US and 12 in the UK to single digits in France, China, India and Japan. We know also that raising them would improve business performance. Finally, we know what good management looks like.

‘So, if something doesn’t work very well, and a (proven) better alternative exists, surely we would expect everyone to gravitate towards that alternative?’ ponders London Business School’s Professor Julian Birkinshaw, who has just spent a year investigating the subject, with fascinating results.

One factor, Birkinshaw and his team surmised, was that management is always approached from the point of view of those doing the managing. Unlike marketing, which has learned to view its function as ‘seeing the world through the eyes of the customer’, managers still see the world exclusively though their own eyes, not those of their employees. One result is s a hopeless mismatch between expectation and requirements on both sides.

This matters, big time, because, underlining yet another ‘duh’, the single biggest predictor of whether you will be engaged and happy in your work is having a high-grade manager. And in this area Birkinshaw’s findings are both extraordinary and damning.

In marketing, many high-performing companies (eg Apple) use something called the Net Promoter Score as a measure of customer loyalty. NPS asks, on a scale of 1 to 10, how likely you are to recommend the company to friends or colleagues. It’s a tough metric, because only 9s and 10s count as promoters, and 1s to 6s as detractors. Subtracting the latter from the former gives a single net score showing how positively (or not) customers view the company.

Now, when Birkinshaw and his colleagues asked employees at five companies to rate their managers in the same way – ‘how likely is it that you would recommend your line manager to a colleague as someone they should work for in the future?’ – there were massive variations. One company posted a NMPS (net management promoter score) of +61 per cent while at the other end of the scale another company scored -28 per cent. But the average was -15 per cent – that is, overall 15 per cent more employees gave their managers the thumbs down than the thumbs up. From an employee point of view, there were more bad managers than good.

Dwell on that a bit. Here we have perhaps the most basic building block of management, the relationship of a manager with his/her immediate report. We have an unimpeachable evidence base. Yet we still manage to get it wrong more than we get it right. In its most fundamental task, getting the job done through other people, management’s effect is negative.

Why do managers find it so hard to do the right thing?

One reason is surely ideological. As Birkinshaw notes, most large organisations continue to operate on a management operating system devised a century ago – bureaucratic coordination, hierarchical decision-making, extrinsic rather than intrinsic reward. In a world where the imperatives of efficiency and compliance have long ago ceded to commitment, initiative and discretionary effort, these principles objectively outlived their usefulness some time ago. But the framework was effectively locked in place by the shareholder-value, free-market doctrines that emerged in the 1980s (which requires all thse things), and they have permitted no movement since.

By reinforcing natural human tendencies to self-interest, control and risk-aversion, ideology makes them self-fulfilling. So even if it wasn’t originally, the behaviour that constitutes good management – focusing on people rather than self, delegating and tolerating mistakes in a larger cause – now runs against the grain. It becomes an ‘unnatural’ act. Put this together with managers’ conflicting priorities and limited time, and the fact that a check-list of things to do isn’t necessarily a good how-to-guide (all the activities require precise judgment so as not to overshoot in either direction), and good management, though obvious, suddenly seems less easy.

Birkinshaw’s research leaves some leading questions.

Why isn’t this stuff taught to all business students from lesson 1?

Why did the last government spend an estimated £70bn – enought to bail out a small eurozone economy – on IT and management consultancy, none of which addresses the elementary management issues?

Isn’t this, as Donal Carroll of Critical Difference suggests, the starting point for a manifesto for a radical, democratic, functional form of management?