CEO pay ratio - will it make any difference?

Posted by
Dr. Scarlett Brown
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The executive pay reporting regulation - requiring UK listed companies with more than 250 employees to report the ratio between their CEO’s pay and their employees’ - will start to come into practice at the start of 2020. Two years on from gender pay reporting and with executive pay in the spotlight more than ever, will this make a difference?

How much our business leaders are paid continues to be a thorny issue, for businesses, investors and particularly for the media and general public. Although the average UK chief executive’s pay has reduced in the last two years (from £3.97 million in 2018 to £3.46 million in 2019) this is still 117 times the average full-time salary (£29,574)[1]. By the 4th January (Fat Cat Day) the average CEO will have earned more than the average worker earns in a year. In the United States the ratio of CEO pay to average employees is 301:1, up from 40:1 thirty years ago. The UK’s ‘say on pay’ legislation in 2013, which gave investors a binding vote on executive pay every three years, has been a trigger for more discussion, but between 2014 and 2018, shareholders approved every single FTSE 100 company pay policy put to AGMs.[2]

At the other end of the scale, we have an increasing problem with low paid work. Four million people in the UK are in-work and living in poverty.[3] As unemployment rates have decreased, this has been primarily through the creation of low paid and precarious jobs. While this might drive short-term profits it also engenders low productivity rates, fragments workforces and negatively impacts economic stimulus. It also has social consequences: income disparity affects educational opportunities, social relationships, health, and life span, and this puts greater pressure on state resources. Whichever way you look at it - a burgeoning low pay precarious workforce simply isn’t part of a healthy economic system.

Pay ratio reporting might just be the answer we have been looking for. The UK has a legacy of using reporting requirements to drive change - corporate governance, modern slavery, gender pay to name a few - but this one works by combining remuneration, which has been on investor agendas for a long time, with a wider social concern for both inequality and executive pay. It puts it in context.

For many of us - even those of us who do actually read remuneration reports - CEO pay can seem out of touch with reality. It is fairly unhelpful to compare quantum with quantum, pay is complicated, and we know the argument that high pay to be at market rate for companies to attract the right people and persuade them to take on a pretty hefty role. Pay ratios tell us more about how the company as a whole prioritises and treats its people and how sustainable their business model is. If a high CEO salary or bonus is only made possible by a large proportion of very low paid employees, it is reputationally and organisationally risky. It gives investors, remuneration committees (and, dare we suggest, remuneration consultants?) a way to view pay that accounts for the wider societal responsibility and reputational risk. This is already starting to come through: While proxy advisors have not yet embedded ratios in their voting intentions, the more forward-thinking investors are. At a recent stakeholder roundtable, Legal and General Investment Management (LGIM) announced they are already considering voting against any a CEO-employee pay ratio of more than 70:1.

Of course, the devil is in the details. It is surprisingly tricky to produce the numbers: companies have to know how many people worked for them through the year and how much they were paid - not as simple as it sounds. Contractors, consultants, and agency workers are not included, but this may significantly skew the numbers, or encourage companies to put their lowest paid workers on these contracts rather than employing them through the business. They then need to report the CEO pay as a ratio of the 25th percentile employee, 50th percentile (median) and 75th percentile, with some explanation around methodology, changes, and any narrative explanation.

While this may be simple and insightful, there is always the chance it can be inaccurate, over-manipulated or oversimplified. When Gender Pay reporting came in, several companies reported no pay gap at all between their men and women, something that is pretty close to impossible unless you have oversimplified your numbers. Companies also presented ‘adjusted numbers’ - reporting their ‘actual’ pay gap and then the gap once they had accounted for differences in, for example, gendered uptake of full and part-time roles, or by women being in lower-paid roles. In doing so they effectively smoothed out or disregarded the biggest drivers for gender inequality: the fact that women tend to be in lower-paid work. They confused equal pay (a legal requirement to pay men and women equal pay for equal work) with the gender pay gap, which is there to highlight the very differences they were ignoring.

But then maybe that isn’t the whole point. Reporting requirements change company behaviour through a concern for reputation and competition with other companies, but also because of the process required to go through to produce the numbers. It illuminates things that they might not have looked for. At this point, before the reports have started to come out, I think we can feel just a little optimistic - that boards will use this as an opportunity, and that it will put employee pay on the board agenda, in a way that helps them to fulfill their responsibilities to the company and to wider society.



[3] Joseph Rowntree Foundation