Keeping executive pay in check and governing successful organisations that benefit everyone
High Pay Day
The median pay for CEOs in the UK’s 100 largest publicly listed (FTSE 100) companies is 117 times higher than the UK’s average full-time employee, meaning that by 17.00 on Monday 6 January 2020, the average FTSE 100 CEO will already have earned what it will take the average worker the whole year to earn. Is this fair? And is it good for business and the economy?
CEO pay ratio reporting requirements
New CEO pay ratio reporting requirements, which come into full force this year, will shine a spotlight on these questions. Alongside the numbers, large publicly listed companies will be expected to provide a narrative explaining how their pay ratios are consistent with their wider policies on employee pay, reward and progression.
The CIPD is calling on employers to take these requirements seriously and treat them as an opportunity to get a better understanding of their businesses and to demonstrate how they value their people. A good narrative would:
- describe their employment models and the relationship to the wider business strategy
- explain the size of the ratios - why they are what they are
- explain what actions have been taken, or are planned to be taken, in terms of CEO and employee reward, especially those towards the bottom end of the pay scale
- describe how stakeholders, such as employees, are being involved in this process.
Three questions RemCos, investors and HR teams need to ask
But research shows that many of the factors fueling the gap between the highest and lowest earners are rooted in flawed assumptions about what drives, incentivises and governs sustainable business performance. Here we explore some of the key questions all Remuneration Committees (RemCos), investors and HR teams should be asking when reviewing their narrative on CEO pay, so they can be sure they’re making sound decisions on executive pay:
- Do long-term incentive plans (LTIPs) really work?
- Is your RemCo fulfilling its duty to oversee fair pay up and down the workforce?
- Are CEOs really the lynchpin of organisational success?
1. Do Long-Term Incentive Plans (LTIPs) really work?
LTIPs are designed to incentivise a CEO to act in the best long-term interests of the organisation. They typically make up around half of total pay for chief executives in the UK’s largest businesses (the FTSE 100). But do they really live up to their name? In practice, most LTIPs are not really ‘long-term’ (they typically only cover a 3 to 5-year time scale), they’re too complex to act as an effective ‘incentive’, and they’re often more akin to a lottery than a ‘plan’.
To decide if LTIPs are right for your business, ask yourself:
- What are your business' long-term goals, and what does long-term really mean?
- Is your CEO adequately incentivised to make decisions that are in the long-term interests of business success? Or could LTIPs linked to financial metrics disincentivise investment in the longer-term interests of the company?
- To what extent do executives understand how their decisions, actions and behaviours influence their pay? Are the behaviours that maximise pay the ones that also truly deliver long-term success for your business?
- To what extent do external factors impact your organisation's ability to predict how much money it will have to pay out through LTIPs and your executives' ability to influence their own pay?
- How does the use of executive LTIPs impact employee experience and performance throughout the rest of the workforce?
- Have you examined the latest evidence on the effectiveness of LTIPs, and are you and your investors satisfied that rewarding executives like investors is the best way to keep shareholder and executive interests aligned?
- Do you understand what motivates people and the unintended consequences that can arise from how incentives are designed? Research indicates that money is not the only way to motivate people nor necessarily the most effective.
Learn more about how LTIPs work and why they're not effective in our podcast.
Learn more about the pitfalls of executive pay.
2. Is your Remco fulfilling its duty to oversee fair pay up and down the workforce?
The UK's Corporate Governance Code asks boards to create a culture which aligns company strategy with purpose and values, and to assess how they preserve value over the long term. It explicitly requires RemCos to review pay across the wider workforce and, when setting executive pay, explain how pay policies are appropriate - using internal and external measures, including pay ratios – in their annual reports. But research shows that most RemCos are ill-equipped to fulfill that role.
To assess the effectiveness of your RemCo, ask yourself:
- What steps is your RemCo taking to ensure that people at all levels of your organisation are paid fairly and proportionately? Is it confident that its pay decisions for top executives are not inhibiting the earning potential of your middle and lower earners by missing opportunities to incentivise CEOs to increase long-term productivity?
- Does it have the diversity of skills, experience and background to ensure the decisions it makes reflect the needs of all of your organisation's key stakeholders? Does it fully understand the reputational risks, opportunity costs and impact on employee engagement?
- Does it make good use of the skills and insights of the company's HR team?
- When setting executive pay, how reliant is your RemCo on external benchmarks and consultants compared with organisation-specific measures of fairness and performance?
- How does your RemCo engage with the wider workforce and take their views into account when making decisions about executive pay?
- To what extent does your RemCo exercise discretion? For example, does it consider how pay decisions might be perceived internally and externally? Does it understand how external factors might influence company performance and pay outcomes?
- How much time does your RemCo spend solely on executive remuneration and where could that time be better spent?
- Does your RemCo understand what’s causing any pay gaps in your organisation? How is this explained to the workforce and what steps is your organisation taking to address the underlying causes?
Read more about the need for greater people expertise on RemCos.
3. Are highly paid CEOs really the lynchpin of organisational success?
The most common justification for high pay for executives is their contribution to the company's share price and the risk of executives leaving and the share price crashing if they don't pay top dollar to the so-called 'super star' at the top. But do you and your investors truly understand what drives success in your organisation and the extent to which your top executives contribute to that success?
To assess the effectiveness of your remuneration practices, ask yourself:
- What does success look like for your business and what legacy is your CEO creating? Is shareholder value enough, or do you also want to have a positive impact on your customers, wider society and the environment?
- Do you and your shareholders truly understand what drives success in your organisation and who contributes to that success? If so, do your remuneration practices reflect that?
- Is your CEO's pay packet good value for money? What evidence do you have for your CEO's contribution to success? Do you understand the opportunity costs, such as reputational risk or lack of investment in R&D or employee training?
- How unique are your CEO's skills and experience? Research with executive search firms shows that for every CEO appointed, another 100 candidates could just as ably fill the position.
- How likely is it that your CEO would leave for pastures new if he or she were paid less? Research shows there is no global market for CEOs and most leaders say pay is not their biggest motivator.
- What steps is your business taking to ensure that success is not dependent on just one person?
- Have you considered broadening the talent pool from which you recruit chief executives, placing more importance on finding someone with the behaviours and competencies needed to successfully run the business than on hiring someone with a track record that comes with a ‘hefty price tag but no guarantee of success’?
- Do you and your shareholders have a clear picture of how much other key decision makers in your business (beyond the CEO) are paid? Is this money well spent?
- Do you know what it would take to increase your organisation’s long-term productivity, so it could more easily afford to increase pay for the lowest earners?
Read more about the challenges around measuring the contribution of individual executives.
Read more about the insights that most corporate reports are lacking.
Why this matters to the CIPD
Work can and should be a force for good – benefiting individuals, businesses, economies and society. But an excessive gap between the highest and lowest earners is not good for business or society: it undermines long-term business success and it fuels social inequality.
What change do we want to see?
Our ultimate goal is to establish a greater appreciation and understanding of why people matter and are worthy of greater investment from employers - and for this to be duly reflected in the way organisations are governed and managed.
To achieve this, we need to:
- Encourage more transparent corporate reporting on pay and performance throughout organisations, particularly among ‘key management personnel’ and the top 1% of earners
- Simplify CEO pay packages and put more emphasis on non-financial measures of performance to incentivise behaviours that benefit all of a company’s stakeholders
- Encourage company boards to reform the way in which pay and performance is governed by replacing their RemCos with People and Culture Committees.
Explore our related content on executive pay
As new research from the CIPD shines a light on multi-million-pound executive pay packages, reforms are needed to more clearly link pay to sustainable performance
Find out what the UK law requires and what this means for HR teams