Myths about executive pay

Deborah Hargreaves, Director of the High Pay Centre discusses the current debate about pay at the top

As Vince Cable begins his consultation on executive pay reforms, it is clear there are a number of myths circulating about excessive pay at the top of the business world. The first is that the debate is somehow “anti-business,” another is that the problem is simply “rewards for failure,” and finally, that shareholders alone can address the issue.

These are convenient stories to tell. It is not hard to condemn “rewards for failure”: it is clearly not right to pay an executive millions in salary, incentives and bonus when he has screwed up.
It is also easy to label those who criticise the system of top pay and big bonuses as “anti-business.”

Again, the argument that shareholders own the company and should be given more powers to tackle pay and left alone, is a handy one for politicians  reluctant to look as if they are interfering with private enterprise.

But these myths distort the real picture of executive pay and divert energy away from more systemic and meaningful reform. The “arms race” in top pay has created a corporate elite that is remote from its own workforce and the rest of the economy. Those running our top companies are drawn from a very small pool and backed up by like-minded executives and bankers operating in a fairly closed world.

As pay cuts and redundancies take hold elsewhere in Austerity Britain, the average FTSE 100 chief executive took home £4.2m last year. Top pay has risen to 160 times median wages in the past 10 years and if current trends continue unchecked, we will return to Victorian levels of inequality in the next 10 years.

This is important for social cohesion – more unequal societies are proven to be more unstable. But it is equally important for business. Wide pay disparities within companies have been linked to a less committed workforce with higher levels of absenteeism and scepticism about management goals. Disengaged workers present one of the biggest challenges facing companies.  The debate about pay is therefore not “anti-business,” but “anti-bad business.”

At the same time, the debate cannot be restricted to one about “rewards for failure.” Executives of our biggest companies are taking home far more than is supported by the public.  In polling for the High Pay Centre, only 7% of the public thought the chief executive of a large FTSE 100 company should receive a package worth more than a million.  These pay awards are part of a system that even some within it, admit is unsustainable.

Of course, it is extremely hard to justify a multi-million pound pay-off for a departing chief executive who has not covered himself in glory. But that is only one part of the problem.

It is very hard to isolate the effects of an individual’s contribution to a company’s success or failure even if that person is the one in charge. This makes it extremely difficult to produce performance-related pay that works.

The result of trying to link executive pay to corporate performance in the past ten years has been excessive complication of top pay, which often comprises six or seven separate salary, incentive and bonus schemes paying out at different rates and times. This means that even the executives themselves sometimes struggle to work out what they will be paid in any one year. At the same time, share prices have barely changed over the past decade when executive pay has soared.

Shareholders are not getting what they think they are paying for. However, this seldom sees them do anything about it. While there have been a small number of votes against egregious pay, these have been few and far between.

Now Cable is offering them a binding vote on pay rather than an advisory one as is currently the case. But the UK has a dispersed shareholder base, in contrast to the block shareholdings that were common 40 years ago.  With investors holding smaller and smaller stakes in a company for shorter and shorter periods of time, it may no longer be realistic to expect them suddenly to intervene more effectively simply because they have been handed a binding vote.

More shareholder involvement is part of the solution to excessive pay at the top, but only part. Shareholders cannot make up for what is, in effect, a market failure.

This is why it is common sense to increase diversity on boards and open up the remuneration committees that deliberate on top pay at businesses. The composition of these committees needs a shake-up to provide the voices that will challenge the pat-on-the-back deals where those at the top are topped up and everyone else loses out.

This needs to be accompanied by a dramatic simplification in executive pay to make it clear and understandable. Most people work for a salary with bonuses awarded in some industries for exceptional performance. But 95% of executives in our top companies took a bonus in 2010. It should be a challenge to qualify for these extra incentives and they should not regularly pay out as if they were part of the annual package.

Cable’s reforms will go some way towards tackling the excesses in corporate pay, but they are only the first step towards meaningful change. If we can dispel the myths that have grown up around pay, we can start to frame the debate in a way that will achieve lasting reform that will be good for business, society and the economy.

Posted on 24 April 2012

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