Executive pay is not simply a matter of fat cats with too much cream
The UK’S annual general meeting season is in full swing, with a number of companies receiving bloody noses from shareholders over the remuneration of their senior executives. The US is also in the midst of its “proxy season”, the first in which public companies have had to disclose the ratio between the total reported pay for the chief executive and the amount paid to the median employee.
Given that many US corporate practices have a habit of making their way across the Atlantic and being adopted in the UK, it is worth keeping an eye on the numbers coming out at the moment. What could this tell us about the likely introduction of pay ratio disclosure in the UK?
The early evidence is that the ratios are coming out lower than anticipated, or feared depending upon your perspective. As of April 26, the median ratio was 72:1 while the average ratio (which is skewed by the outlying companies with the very highest ratios) was 148:1.
What is the right ratio? There is no easy answer to that question. The Greek philosopher Plato said that the best paid should not get more than five times what the worst paid received. George Orwell thought 10:1 sounded about right.
Management writer Peter Drucker was uncomfortable with anything above 20:1, a number with which the legendary financier JP Morgan apparently agreed.
All of these thinkers would clearly be appalled by the dizzying numbers being generated by modern corporate America.
But modern working practices and business structures, not to mention the size of a company and the industry in which it operates, all play a role in shaping the range of pay between those at the very top of the corporate pyramid and those at the bottom.
Some of the highest ratios are in sectors such as consumer goods, healthcare and, possibly, technology. Companies in the real estate, utilities and financial sectors have some of the lowest ratios. The disparity in pay could be based on the degree to which companies are “leading edge”, or digitally driven, compared with other more traditional business sectors.
Given all that, is a single number more misleading than it is enlightening?
For one thing, the “better” sectors often grant equity to staff lower down in the organisation so that pay in the middle of the organisation is reported to be higher, even if it never pans out.
In the case of tech firms, you have to beware how companies are classified: Amazon (higher ratio) is really a logistics company, while Apple and Google have lower ratios. Amazon has a lot of warehouse workers; Google does not.
In part, the ratios are skewed across sectors based on the fact that the US Securities and Exchange Commission does not allow companies to use full-time equivalent pay for part-time employees.
So those companies that rely heavily on part-time workers will inevitably have lower median employee pay figures. In the UK, we must wait to find out how companies will be asked to approach the calculation of chief executive pay ratios.
The driving force behind the introduction of this legislation is something very significant: the growing disparity between the pay of chief executives and workers at a time when there has been no corresponding change in the chief executive’s role or the company’s performance. In general, we can expect an impact from this type of disclosure, but what impact are we looking for?
In the UK, companies are already required to disclose how the annual change in chief executive pay compares to the annual change in pay for the average of the workforce.
Movements in executive pay relative to the workforce are clear; the ratio will simply show the scale of the difference. Will remuneration committees be under pressure to lower executive pay, to improve their ratio, or push up employee pay? Will the ratio sway shareholders in their decision to vote for or against remuneration policies?
As is always the case when looking at pay policy, we should be careful about what we wish for.
There is no doubt that some chief executives are worth every penny of the pay they command. One would hope that a chief executive who commands a high price for driving success will not be made a scapegoat.
Just as there is no right answer to the question about what a chief executive is worth, there is no “reasonable” ratio. It will vary from company to company, from early start-up to mature, from struggling to thriving.
Unlike in the US, where a company’s entire workforce must be considered, preliminary discussions suggest that workers’ pay will be based on a firm’s Uk-based employees.
So at least we won’t find ourselves scrambling to understand how the ratio is skewed by the proportion of the overseas workforce.
Some US companies have seen ratios skyrocket as the median calculation of pay for the workforce includes employees in lower-cost countries, where workers are paid a lot less than their US counterparts.
There are likely to be serious technical issues in how the ratio is calculated in the UK too. For one thing, how do you calculate the chief executive’s pay? The Government has proposed the single figure that is revealed in the company report each year. However, this number varies enormously from year to year, reflecting the value of vested longterm incentive payouts. Those payouts, as the name suggests, are reflective of efforts over many years but are only reported when paid.
A change in chief executive has a similar impact, effectively pushing the ratio in the other direction while incentive pay remains unvested.
In short, we should be prepared for the UK ratio numbers to be highly volatile. If we are looking for answers, and drawing conclusions for future pay policy, it will be hard to see them.
‘Movements in executive pay relative to the workforce are clear; the ratio will simply show the scale of difference’