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Doubts raised over effects of CEO-worker pay ratios

30 August 2017 by Jimmy Nicholls

Doubts raised over effects of CEO-worker pay ratios - Read more

The duty to publish ratios receives a mixed reception, as backers call for more and critics downplay its impact.

Experts are questioning the British government's decision to force some 900 listed companies to publish the pay gap between their chief executives and the average of their UK workers.

Under the proposed corporate governance reforms, affected companies must publish the pay ratio annually alongside a narrative explanation of year-to-year changes and conditions among their staff based in the UK.

Chief executive pay will be based on their total annual remuneration – the so-called ‘single figure’ from the UK directors’ remuneration report – while worker pay will be an average of the total pay for the UK-based staff.

The measure has received widespread support from lobby groups, despite some concerns it will fail to deter excessive pay, that it is invasive, and that there is a risk that the statistic will be used without the necessary context.

Better informed

Stefan Stern, director of the High Pay Centre think tank, told Governance and Compliance: ‘We do think it will be important to bring rationality and a sense of proportion for top pay.

‘This is one option for businesses to be more intelligent and thoughtful for pay throughout the organisation. It is like stepping on the scale more often – you can calculate your weight gain.’

The reforms come after a green paper on corporate governance put out last November, which prompted a wide-ranging consultation with industry.

Detailed proposals of executive pay reporting duties will be set out in a draft statutory instrument later this year, with the measure slated to take effect in June 2018.

Alongside this, the government is proposing to have all listed companies with ‘significant shareholder opposition to executive pay packages’ publicised in a new public register, as well as efforts to have employee views represented in the boardroom.

On pay ratios, Chris Hodge, policy advisor at ICSA, said: ‘If you see the purpose of the pay ratio as being to give investors better information on which to assess companies’ remuneration practices, then it is a welcome addition.

‘If a company’s ratio increases year on year for no apparent reason, or if it is significantly out of line with other companies in the same sector, that ought to be a red flag that prompts investors to challenge the company to explain why that is the case.’

Reporting support

The government said that in the consultation, those who responded to the pay-ratio reporting proposal backed the practice, with the greatest support coming from institutional investors, society groups, think tanks, academics, and members of the public.

‘Three quarters of quoted companies were opposed to pay ratios,’ the government said in its consultation response. ‘Business representative bodies, professional bodies and advisers were fairly evenly divided on this question.’

Other interest groups also backed the proposal.

Philippa Foster Back, director of the Institute of Business Ethics, said: ‘Our surveys show the high level of executive pay is one of the major factors undermining public trust in business.

‘Fundamental reform is needed, and this must come from within the market itself. The government will have done everybody a service if the requirement to publish pay ratios prompts a thorough rethink of how the whole process works.’

Ben Willmott, head of public policy for professional body the CIPD, said: ‘The CIPD has been calling for the publication of pay ratio between CEOs and their workforce since 2015 so we welcome the government’s plans to introduce new laws to address this.

‘Our research has also shown that high levels of CEO pay can demotivate the wider workforce, which can have a wider impact on engagement and productivity, so it is right that this is addressed through greater transparency and accountability.’

Disputed form

As well as a ratio between chief executives and average UK workers, some people support further reporting.

‘I am very happy that the principle of pay ratios has been established,’ Stern said. ‘This could be a start of some useful discussions about pay variations. What is the appropriate gap between a manager and his or her team?’

However, Jamie Whyte, director of research at the Institute of Economic Affairs think tank, told Governance and Compliance: ‘I think that the difference between average income and the CEO’s income is an utterly bizarre measure.

‘What that ratio is depends on all sorts of things.’

He added that the publication of pay ratios could ‘perversely incentivise’ certain kinds of behaviour, such as discouraging cuts in highly-paid staff, since this could increase the disparity between average worker pay and CEO pay.

‘Another obvious perverse incentive it creates is to outsource,’ Whyte said, referring to the practice of hiring low-paid staff through contractors, which would not be recorded in pay ratio data.

Peter Swabey, policy and research director at ICSA said: ‘The most important thing is how the pay ratio statistics are used. Year-on-year comparisons in the same company will be potentially helpful, as may the contextualisation of pay ratios between different companies in the same sector.

‘What will be unhelpful will be comments based on the comparison of pay ratios in totally different companies or sectors, without the necessary context to understand why these may, or may not, be necessary.’

Superhero executives

The move from the government will prompt further debate on the legitimacy of huge pay for chief executives which some have described as ‘excessive’.

An analysis in February from The Equality Trust, an advocacy group, found that FTSE 100 chief executives were paid £5.3m in 2015 on average, or 190 times the average UK annual wage.

‘I think we should ask why one human called CEO should be paid 200, 300 or 400 times what another human is being paid,’ said Stern.

‘Too many boards buy into the mythology of the superhero CEO. From a governance point of view you do not want CEOs taking decisions on their own. They should not get so much disproportionate credit.’

Whyte rejected the notion that excessive pay was a problem, or that the government should intervene in the remuneration between executives and company owners.

‘The arrangement is people who own the company choose to pay the senior management and the CEO a certain amount of money, and they bear the cost of that,’ he said. ‘They are only willing to pay more when they think it is worth it.’

He also argued that companies would be able to misrepresent executive pay in statistics. ‘You can pay people in so many different ways,’ he said. ‘I presume [the proposal] is trying to capture it all, but it is almost impossible.’

Either way, ICSA’s Hodge thought that those wishing to bring down executive pay might not get their way.

‘If you believe the purpose is to bring down executive pay in absolute terms, or to ensure that the workforce as a whole shares equally in the success of the company, then I suspect you may be disappointed,’ he said.

‘We have seen ever more transparency about executive pay over the last twenty years yet it has continued to increase, so I do not see any reason to believe that this particular disclosure requirement will succeed where others have failed.’

Swabey agreed, adding: ‘Of course this measure only addresses issues of high pay in listed companies; it does nothing to address high pay in other sectors of our society, and it is difficult to see why high pay in listed companies is any different from that in private companies, professional services or the sports or entertainment industries.’

Jimmy Nicholls is deputy editor of Governance and Compliance

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