From the TUC

More for Less: pay at the top

18 May 2011, by in Economics

The High Pay Commission (HPC) – whose commissioners include TUC Deputy General Secretary Frances O’Grady – has brought out its interim report. It includes a blizzard of charts, figures and tables that clearly establish that executive pay has increased rapidly over the last fifteen or so years and has left the pay of average workers trailing far behind. Average FTSE 100 CEO total pay was 145 an average worker’s salary in 2010, and the HPC calculates that if current trends continue by 2020 the multiple will be 214.

The report also shows that rapid rise in executive pay does not reflect company performance or returns to shareholders: earnings per share actually fell by 1% per year between 1998 and 2009, while earnings of FTSE 100 CEOs rose 6.7% per year over the same period. To sum up: executive pay awards are neither fair nor linked effectively to performance. In other words, the current system is not working.

The HPC report makes a strong case that fairness in pay matters to society and that the exponential growth in executive pay has eroded public trust in companies.  There is less focus on the business case for reform, but the report does quote HPC research with focus groups of employees that suggests that large pay disparities within a company have an impact on employee engagement. Given that employee engagement has been shown to be an important predictor of company productivity and performance, this contributes to an argument that wide pay disparities are bad for company performance.

This is indeed backed up by other academic evidence: different studies have clearly shown that wide inter-company pay disparities are associated with lower company productivity and/or performance. Alongside societal disquiet at pay disparity and the wider economic and social costs of inequality more broadly, this provides a powerful argument for change.

The HPC leaves the million dollar question (excuse the pun) to its final report, which will be published in the autumn: what should be done to reform executive pay? But its analysis of the causes of the problem suggest some clear pointers for reform. As it points out, the attempt to link executive pay to performance has been a major contributor to the massive increase in executive pay over recent years, as ever-higher multiples of ever-higher salaries are tied to ever-more opaque targets set at a level that mean the majority of schemes pay out year after year. We know already both from academic studies and from repeated observation that the attempt to link executive pay to performance has not worked, and in many cases supposedly incentive-related schemes end up paying for poor and mediocre performance .

In addition to this, there is a whole literature on incentives that questions the assumption that performance-related pay will boost performance: on the contrary, studies have shown that trying rewards to performance generally leads to lower performance (for a whole range of reasons including what is called ‘motivation crowding’). Reliance on performance-related pay as the solution to spiralling executive pay has failed, and it is high time that this is recognised and new approaches developed.

The report also discusses board culture and remuneration committees, conflicts of interests and remuneration consultants, the role of shareholders (only a handful of remuneration reports have ever been rejected by shareholders) and how the labour market for top executives fails to operate effectively, all of which have contributed to the problem of spiralling executive pay.

Finally, the report  highlights three areas that it will be looking at for policy proposals: transparency, accountability and fairness. The challenge for the HPC will be to apply these principles to the process and context of setting executive pay to come up with policy recommendations that will really make a difference in practice. A hard task, but one that desperately needs to be done.