CIPD Voice: Issue 26
Our new report
The median pay among the leaders of the UK’s largest listed firms was £3.61 million in the financial year ending (FYE) 2019, according to Executive Pay in the FTSE 100 report from the CIPD and the High Pay Centre. This amount is down marginally on the £3.63 million recorded for the FYE 2018, but the smallest it’s been since 2011 when it was £3.79 million. Over the past decade, CEO pay has been as low as £2.27 million (2009) and as high as £3.97 million (2017).
But are the pay levels enjoyed by these chief executives appropriate? The headline figure of £3.61 million is large in comparison to HMRC median UK pay data, or the average pay packet of FTSE 100 workers, or the UK’s Prime Minister’s salary, or for being Scotland’s First Minister, but perhaps less so when compared with wages of some Premiership footballers, film actors and CEOs working from the USA or in non-listed companies.
Whether an amount is seen as problematic depends ultimately on the perspectives of an organisation’s stakeholders, such as employees, remuneration committee (RemCo) members, investors, HR, the media, regulators, customers, consultants, the CEO themselves, to name but a few. However, between these various parties, opinions can differ.
And it can also be hard to find consensus inside these stakeholders about what’s the appropriate level of remuneration. For example, within the investment community, institutional shareholders might have differing perspectives to those of private investors. Similarly, overseas-based shareholders, such as sovereign wealth funds, can have varying attitudes influenced in part by national cultural sensitivities. Some funds may be focused tactically while others strategically. And there’s also the views of proxy advisory firms to consider.
While a maximum pay cap or ratio may look superficially appealing, this lack of agreement between and among stakeholders about the ideal level of CEO remuneration is one of the reasons why the CIPD has never advocated it.
How CEO's are paid
While how much CEOs are paid attracts a lot of scrutiny, less attention is often given to how they’re paid, which is something the CIPD has been trying to rectify. CEO reward is underpinned by the concept of principal-agent (or agency) theory. Broadly, this recommends that more focus be given to evaluating and rewarding the outcomes, than on managing the behaviours (the inputs) that led to those outcomes. In order to align CEO interests (the agent) with investors (the principals), executives should be paid for the most part through short-term bonuses (STIPs) and long-term incentives (LTIPs).
Academic studies of CEO reward
However, there are problems associated with agency theory. The report Executive reward: drivers and consequences, a CIPD-commissioned review of academic studies of CEO reward carried out by the London School of Economics, didn’t find overwhelming evidence that this pay for performance approach actually worked. In part, this is because the studies analysed use a variety of perspectives, definitions and time frames. This is also due to the theory’s assumption that the most effective way to get CEOs to perform is through extrinsic rewards, which might not always be the case.
This report identified behavioural science as a useful way of exploring the issue of executive remuneration further, because it considered the issue from the standpoint of CEOs themselves. It noted that variable pay designed with alignment in mind is usually complex, with performance benchmarked against comparator firms and subject to considerable delay. However, it pointed out that complexity and delay is problematic in that it can reduce the motivational impact of the pay. In effect, you can’t be motivated by something you don’t understand, or feel you have control over.
Therefore, alignment between the principals and their agents can result in the creation of pay practices that aren’t fully valued by CEOs; the value of LTIPs and STIPs having to increase in order to be motivational; and inappropriate behaviours unwittingly incentivised. In addition, some CEOs may find the assumption that the only way to get them to do the right thing is by dangling suitably sized LTIPs and STIPs in front of them vaguely insulting.
Changes into CEO pay
Given the above, one of the changes the CIPD would like to see is for RemCos and corporate stakeholders to collaborate to investigate the various alternatives to the current approach of STIPs and LTIPs, such as deferred shares. That is not to say that we want to see the end of short-term and long-term bonuses and incentives, rather we want to see a more bespoke approach to remuneration being adopted.
Another that we would like to see is that RemCos and stakeholders look at a wider range of measures to assess and reward success. While there are moves to link more CEO bonus and incentive pay to non-financial indicators of performance, such as around employees, customers, the environment, etc, a forthcoming CIPD-commissioned report finds most of it is still linked to financial measures.
Rather than identifying why the use of non-financial measures is not more common, this new report is aimed at kickstarting a conversation among stakeholders about the problems facing them when looking to better link CEO pay with people management, development and reward outcomes.
The challenges that executive pay brings with it
Potentially, there are several challenges that might need to be overcome. One is that there are no common definitions of some people measures, such as engagement, which then makes comparisons difficult for shareholders. Another problem is that not all people measures are universal, so investors could be unsure which ones to apply in certain contexts. We will build on this initial report in the coming months by exploring with stakeholders how these, and other, problems can be overcome.
The CIPD would also like RemCos to have broader responsibility for governing people and culture, so that CEO pay setting is not perceived as being out of touch from what’s happening on the shop floor and in communities. We believe that this would help to ensure that reward encourages the right kind of behaviours in business – the kind of behaviours that would benefit firms, employees and wider-society.
That’s why we’re building on our previous research by exploring in 2021 what a broadened RemCo could look like and how it could function, the metrics, insights and support it would need from people professionals as well as the implications for the organisation, such as investment in HR technology. We believe a broadened RemCo would be better placed to understand the varying perspectives around pay and to help foster the consensus needed among stakeholders to help develop something more appropriate to its setting.
The effects of the pandemic
The double whammy of COVID-19 and the subsequent economic lockdowns, has had a profound impact on the workplace, the workforce and work itself. While some employees report an increase in their financial security, CIPD research finds that many more have reported a fall. In addition, the increased workloads for some key workers has increased their stress levels.
It’s against this backdrop that executive pay decisions will be judged. H. L. Mencken once observed that for every complex problem, there’s a solution that’s simple, obvious, and wrong.
If executive pay setting is seen as disconnected with peoples’ lived experiences, then the danger is that the simple, obvious and wrong solution will be found. As HR professionals know, people problems are usually complex and so often require complex answers. However, the CIPD is playing an active role in helping the actors involved with CEO pay find acceptable solutions.
Charles Cotton, Research and Policy Adviser, Performance and Reward
Charles has recently led research into the business case for pensions, how front line managers make and communicate reward decisions, and managing reward risks, as well as the creation of a good practice guide on the annual pay review process. He is also responsible for the CIPD’s public policy work in the area of reward and is a Chartered Fellow of the CIPD.