CIPD Voice: Issue 20
Fairness is a hot topic. How people feel they have been treated often makes the news, everything from being mis-sold financial products to sexual harassment have generated headlines.
In the world of work, the fairness of pay decisions is an important issue for employers and employees as well as for customers, investors, public commentators and politicians. We have had such initiatives as gender pay gap reporting and proposals for employers to disclose pay by employee ethnicity.
Responding to concerns about unjustifiable pay disparities within firms, the Government has introduced reforms to improve corporate governance and ensure that CEO pay is fair and appropriate.
The UK Corporate Governance Code requires boards to give stakeholders beyond the company’s shareholders – such as their workers, customers and wider society – a voice in corporate governance structures. And from 2020, new reporting regulations require all large listed companies to report and explain how chief executive’s pay compares to other employees, as well as explain how boards take stakeholder interests into account.
To explore the extent to which the FTSE 100 firms are responding to the corporate governance new standards when it comes to rewarding their most senior executives, the CIPD and the High Pay Centre explored the remuneration received by CEOs in these companies for the financial year ending 2018.
Our analysis finds high levels of CEO total remuneration, but little little evidence to justify that CEOs deserve their pay packages. If we rank FTSE 100 CEO single figure pay from the highest to the lowest amount, the single figure in the middle of this ranking (defined as the median) is £3.46 million. This amount is 13% lower than that recorded in our previous report (£3.97 million). While FTSE 100 CEO pay has dropped, it would still take a full-time employee earning the median national wage 117 years to earn what a CEO does in one year.
However, evidence to justify CEO pay levels is weak. Firm performance (as measured by changes in the company’s share price), employer size (both in terms of market capitalisation and staff numbers), and investor dissent all seem to have limited influence over CEO pay according to our analysis.
Our analysis also finds that other senior FTSE 100 executives have received large payouts, sometimes higher that the CEO’s total remuneration. The median pay for ‘key management personnel’, which includes the chief executive as well non-executive and executive board members and senior managers, is £1.09 million.
Our investigation finds 48% of chief executive pay is made up of long-term incentive plans, which can vary from year to year due to several factors, some of which might be outside the control of the CEO, such as government policy or political risks. Finally, despite efforts to improve boardroom diversity, if you are a FTSE 100 CEO, you are more likely to be named Steve or Stephen than you are to be female. There are only six female CEOs in this year’s analysis and they were paid 32% less than their male counterparts.
But what does this mean?
The first thing to note is that while CEO median pay has fallen, it has been bouncing up and down between a range of around £3.5 million and £4 million since 2011, so it could rebound next year, rather than being the start of a downward trend. Perhaps more important than how CEO reward has changed is whether it signifies value for money. However, our research finds only a limited link between chief executive pay and company performance or size.
Against a backdrop where UK average earnings have still not recovered in real terms from the 2008 financial crisis, employees will think it is unfair that the achievements of their CEOs are generously rewarded while their own efforts are not. For instance, 39% of respondents to a CIPD survey of workers found that their CEO’s level of pay didn’t encourage them to go the extra mile for their employer, while 17% said the opposite.
Shareholders are more likely to vote against giving CEOs a pay rise than they are to vote against the policy that resulted in that rise in the first place. This possibly indicates that because of the complexity of some pay policies, some shareholders do not fully understand the potential reward outcome that they are voting for and so only react when they realise how high the payouts could be.
While CEOs have been the focus of attention, other senior managers can also be a significant business cost. However, our analysis suggests that current reporting is inconsistent as to who the key decision-makers are and why they get paid so much. Investors will want to know if this money is being spent wisely or could be better invested in research and development, or employee training.
The continuing use of long-term incentives could be seen as surprising given the interest in alternative pay mechanisms, such as from the Investment Association Executive Remuneration Working Group. Behavioural economics suggests that because of how these rewards are designed in terms of the measures used, or the form of reward given, many CEOs may not value them fully. Similarly, by focusing on financial outcomes, firms may be failing to recognise other drivers of performance, such as how people are managed and developed.
In 2019, it’s disappointing to see so few female CEOs in FTSE 100 firms. Unless we start to see more women in senior positions, progress in reducing the size of the gender pay gap will be slow. In addition, research suggests that firms that lack gender diversity are often outperformed by those with more equal numbers of men and women. This ought to be of concern to business.
What is to be done?
How pay is distributed within firms is failing both business and society: it’s not fair and it’s undermining long-term business success. While the CIPD welcomes the revised Corporate Governance Code and CEO reporting requirements, on their own we think they will have only a limited impact. For this reason, and to address the concerns raised by our research, the CIPD and the High Pay Centre recommend: that single figure reporting requirements and guidance should be extended to cover key management personnel and pay for the top 1% of earners disclosed, to further improve transparency and ensure this area of reporting practice improves. This will help build trust among people about how their and other individuals’ efforts are rewarded and allow investors to appreciate where and how the money on pay is being spent.
Firms should establish a formal 'people and culture' committee in place of their remuneration committee, or at least broaden its remit, to consider issues such as organisation culture, fairness and wider workforce reward policies. This will help ensure that pay decisions will better reflect an organisation’s purpose and performance.
Companies should also ensure CEO pay reflects both financial and non-financial performance measures such as indicators of diversity, talent management and employee well-being. This will help ensure that the behaviours that drive company value are rewarded appropriately.
Finally, organisations should simplify CEO reward packages and ensure they are linked to fewer, but more meaningful measures of performance. Complex incentive plans can be just as confusing for CEOs as they are for shareholders. Smaller, simpler and more immediate bonuses could be both more motivational for CEOs and easier to understand for stakeholders.
To help reward and people professionals review their approach to executive pay the CIPD has created the following web page and resources on the truth about executive pay.
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.