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The new pay ratio rules - how they’ll work and why they’re needed

Blog by Luke Hildyard for the IPA bulletin

This summer Parliament approved new laws requiring UK-listed companies to publish their CEO to worker ‘pay ratio.’

The disclosures will show what the CEO makes in comparison to the workers at the 75th, median and 25th percentile of the pay distribution of the company’s UK employees (ie those in the top quarter, in the middle and in the bottom quarter of earners in their company). These comparators have been chosen because companies are already required to calculate them for their gender pay gap reporting obligations. Therefore, the pay ratio reporting ought not to represent a significant additional reporting burden.

A similar reporting requirement has already proved controversial in the US, where 12 S&P 500 companies have reported that their CEO earns more than 1,000 times their median employee. At toy manufacturer Mattel, the ratio was nearly 5000:1.

Ratios in the US are likely to be much higher, owing to the fact that CEO pay packages are much higher in America and the reporting requirements cover the company’s global workforce, rather than just the domestic employees as in the UK. Nonetheless, once the disclosures begin to appear in UK companies annual reports in 2020, they are likely to be of considerable media and public interest. Currently, a FTSE 100 CEO is paid roughly 160 times the average full time UK worker, compared to around 60 times in the late 1990s. Very high pay for top executives and other leading professions including finance, law and consultancy has made the UK one of the most unequal countries in Western Europe. The share of total UK incomes going to the richest 1% of earners has gone from around 6% at the start of the 1980s to the most recent estimate of around 14% according to the World Inequality Database, an international academic initiative. Similarly, the share going to the top 0.1% has risen to nearly 6% from under 3% in 1990.

Inevitably, the first pay ratio disclosures will be sensationalised to highlight individual executives and companies with the widest pay ratio. Critics have seized on this as evidence that the reporting requirements are flawed and will result in the retail and catering industry being traduced (companies in these sectors are likely to have very high pay ratios, because of their large number of low-paid staff) while investment banks get off lightly. However, theses criticisms are mis-placed.

Most comparisons will be made with companies in other sectors, and even where they are made across corporate Britain as a whole, are likely to provoke a useful debate about pay and working lives. The gender pay reporting sparked an ongoing discussion about, why it is more difficult for women to reach top positions, how this differs across industries and how individual companies have overcome these challenges to enable more women to fulfil their potential. Similarly, ratios can show us the scale of pay inequalities and encourage people to question what it is that causes the gap between those at the top and everyone else, what are the consequences of this gap and what measures could we implement to close it  (in relation to education and skills; improved corporate governance; or workplace voice, for example). Many companies are now taking action to address their gender pay gap – pay ratio reporting will create further pressure to reduce the gap between their highest and lowest earners.

The figures will provide ammunition for trade unions and anti-poverty campaigners, for example. It is currently very easy for executives to suggest that they would like to offer a payrise for their lowest-paid workers, but the company cannot afford it. When public pay ratios show the difference between what those at the bottom are getting compared to the top earner or top quarter of earners, it becomes a lot more uncomfortable for the Chief Executive to justify to their workers or to public opinion.

Of course, it is not the case that pay ratio disclosure will solve all the problems associated with top pay and inequality in Britain with one stroke of a pen. Multiple problems remain with the UK’s corporate governance system, which concentrates power and influence in the hands of disengaged shareholders while giving workers little say in the running of their companies. Similarly, Directors’ duties in company law elevate the interests of shareholders above all other stakeholder constituencies, meaning that boards are discouraged from running their businesses in a way that accords with the interests of wider society.

However, better transparency over companies’ pay practices is certainly to be welcomed. To achieve a fair pay culture across the UK with full public confidence, we need a clear understanding of how pay is distributed and why. These new requirements are a helpful step in that direction.

Posted on 13 August 2018

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