Moral hazard

Over the last decades we have seen everything about the good and the bad of free market economy; we have learnt a lot about the consequences of moral hazard. Moral hazard is the tendency for one person to engage in riskier behaviour when the consequences of this behaviour will be dealt by others. One example might be an insured shop owner, struggling, who will not have any incentive in investing in a new fire system as, after all, a fire would permit them to collect the premium of the insurance. The insurer does not have complete information on the behaviour of the insured or their intentions, therefore will incur a higher risk than the risk of fire in itself. However, this typical example does not adequately illustrate when moral hazard occurs at the level of management.

The 2006/7 financial crisis was an astounding example of moral hazard, where many groups of people accepted higher risk they should have done (banking management, intermediaries and the recipients of sub-prime mortgages). Let’s focus for a moment on the management within financial institutions as it is a more appropriate example of what I will have to say. Before the financial crisis unfolded, executives were either aware of the problem, and they defrauded millions of people, or they were not, they were just incompetent. Were they deserving their jobs and the substantial compensation schemes they had and still are receiving? Is the market setting this compensation packages? I will come back to this point later. Either way, the initial response of Governments was difficult: bailing-out private institutions, reinforcing the possibility for moral hazard to incur in the future, or let the system fall in an uncontrolled manner? Considering the situation, most Governments decided for supporting financial institutions, therefore reaffirming that management of financial institutions may have operated under moral hazard: as the fall-out of their riskier behaviour was, in very large part, handled by States, Governments and the People.

But this blog-post is not about the financial crisis.

The University of Bath ‘affair’

Over the last few weeks, national news in the UK reported on protests of employees and students at the University of Bath on regard of the high salary earned by Dame Prof Glynis Breakwell, their Vice-Chancellor (~£468,000 and benefits). Reports were initially accurate, but they got occasionally derailed by attempts from various academics to defend high salaries for academic governance in general or Prof Breakwell specifically. Let’s clarify immediately, I do not have an opinion about how much a Vice Chancellor should be paid. Half a million may be the right number, or it may be too low or too high, I just do not know enough. But a few things bothered me in this debate: responsibility, accountability, and gender equality.

The market sets compensation schemes, does it?

I have read the commentary written by Prof. David Blanchflower and published by The Guardian, entitled “University vice-chancellors deserve more pay, not less. Here’s why”. The reasons for high salaries described in this article are clear and even agreeable at first instance. Universities have to hire their governance in a global market with competitive salaries. I have nothing to debate about this truth, but I am afraid there is another truth, not too hidden, that went unnoticed here. The protests were not a generic complaint about the high salary of academic leadership, it was a specific complaint about an almost 4% salary increase for the highest paid Vice-Chancellor. Allegedly, compensation for the governance at the University of Bath was established with insufficient transparency, with an undeclared conflict of interests and a motion from the Court of the University was hindered by those that should have left the room during a vote because of conflict of interests. This is not my opinion, but the informed and competent judgment (I suppose) of HEFCE, the Higher Education Funding Council for England. If you are interested in this story, please read their report.

Is moral hazard or the market that set salaries?

I am no economist, but my naïve opinion is that this is a typical case of moral hazard in management. As discussed, moral hazard takes many shapes and forms, but it has been identified as a dominant reason for the uncontrollably increasing compensations for executives in Industry. It is true that Academia recruits on a global market, but Academia must shape the global market both training adequately future executives and leading by example.

There is a debate, until now unrelated to Academic governance as far as I know, about the compensation of executives that appears to have become untenable, influenced by executives themselves, paying marginal consequences when their actions damage the brand they represent.

Let’s say you have the right not just to ask a pay rise, but to vote in favour or against. Let’s say that you give yourself a million pounds per year, irrespective of outcomes, in addition to a complex package of benefits that may depend on the performance of your company. After one year of work, your company goes bust and you have lost the value of your shares and options. However, you have just earned 1 million in 1 year, that is an amount of money that corresponds to 37 years of median salary. So, corporate executives raise their pays (not all of them!), constantly, to capitalise on short-term investments, possibly (even unintentionally) misjudging the consequences of their decisions as their livelihood, and those of their families, contrary to the vast majority of people, do not really depends on their productivity. This is moral hazard.

Executives are entitled to ask for an increase of income, but the procedures for these extraordinary compensation packages (from the point of view of people paid ‘normal’ wages or unemployed) shall be transparent and not just justifiable but justified.

I do not believe that this is a common issue at Universities, but how the story unfolded at the University of Bath resemble one of these cases. Let me do an example.

Dame Prof Breakwell is paid a high salary because she has to look after public relationships and take important executive decisions for a large business and an important brand. True. Complaints about the pay rise should have been expected, so a high degree of scrutiny. The Council voted down a motion of the Court requesting more transparency. In authorising the pay rise in a period of protests about wages and trying to quench the formal protest at the University Council, some (let’s be clear not all) academics accepted the risk. This was a misjudgement, and now the University brand will pay the consequences. At the time I write, Dame Prof Breakwell will retire, after six months paid sabbatical and with a written-off loan: isn’t this moral hazard?

Are Vice Chancellors paid too much?

It is not that Vice Chancellors are paid a too high salary, but the problem is transparency, respect of the opinions of your employees and ‘customers’ (the students I suppose), respect for the brand one represents and, a better understanding of societal changes. I hope that other Vice-Chancellors will be proactive, not in cutting down their incomes (this is a different matter), but in understanding and shaping societal changes.

Universities have the moral duty to shape society not to be just the mirror of it. What some people might not appreciate is that the uncontrolled rise in executives compensation (in Industry) is causing damage to business three folds: by draining resources from investment to disproportionate personal wealth, by inducing short-sighted selfish behaviour with no incentive for long-term investment in assets and people, and bad publicity to industry creating a sense of complete disconnect, distrust and unethical behaviour that damage the brands they should promote. The latter point is often neglected, but it is very important. A chancing society and pressure groups, if neglected, can cause a lot of damage to a ‘brand’. This is not in Academia but in the world of Finance and Big Industries. Are we walking the same path now? Most people will say no, as compensation packages for academic governance are far from the excesses of USA corporations (true), but as I tried to say a few times by now, the issue is not necessarily the pay level, but the process and incentives in place.

Fully justify high salaries and adopt transparent decision processes, but also do not disregard the growing intolerance for inequality. Do not speak, in an abstract manner about the market, be specific. Moral hazard is part of the market, it is an unfruitful degeneration of it, which goes against the principles of free market economy. Most Academics and University employees dedicate their lives to improve society. Sometimes we are wrong, other times ineffective, but most of us, Vice-Chancellors included, are well-intentioned and passionate to make of the future UK, a competitive global and fair Nation. Therefore, do not let greed, or simply lack of due process, to damage our brand and collective efforts.

Was gender an issue?

There is another ‘inequality’ that bothers me: gender inequality. The top-level academic world is dominated by man. I am a white nearly middle-aged man, with the ambition to become a ‘fully-fledged’ academic. However, I cannot avoid noticing that women representation among academics is still low and it pains me that to get in the line-of-fire was a successful woman. I do not know statistics about Vice-Chancellors and gender-balance, but I did check the Russel Group. I count six female Vice-Chancellors and seventeen males, ~25% female representation, a figure we are too often familiar with. I am sure that all Universities are committed to improving, we feel very strongly about this at the University of Cambridge, but the historical heritage of male-dominated academia take a while to change.

The Guardian published another letter in support of Prof. Bakewell, this time signed by several female academics of the University of Bath, which start with “Being a successful woman seems to attract a disproportionate degree of negative criticism”. I am sure that this is true, but I should clarify that gender, for me, did not matter, and also for the articles and material I had the opportunity to read. The highest paid Vice-Chancellor in the UK was, by chance, a woman. HEFCE criticised procedures that were opaque, behaviours trenched in conflict of interest. When a woman raises at a position of power is, first and most importantly, laudable because being one of the best in their area irrespective of gender. Second, a woman in a position of power in a male-dominated environment is also laudable because of the many obstacles that women still experience in career progression, particularly at the top of the scale. However, people of power should accept the increased scrutiny and the responsibilities that come with the higher salaries they are paid, irrespective of gender and background.

Leadership for the future

My hope for the future is to see inequalities of all types to diminish and eventually disappear. I hope to see more women in academic governance. Irrespective of gender, I wish our leadership will keep fighting to improve the society we live in, fight against the profound inequalities we experience even in the United Kingdom, be this income or gender inequalities. I wished we trained the economists, the bankers and the lawyers that will reach the apex of various Industries to lead change. Because the only way we can defend a free market economy is to ensure that the right checks and balances are in place, monopolies are not created, packets of extraordinary wealth (corporate or individual) do not exist (otherwise they distort the dynamics of competition as much as a monopoly).

Let’s never say “it is the market that decides” because it is always people that decide, and it is ok if we follow due process.