Annual reports reveal what the UK’s top executives earn, but present little evidence to justify their share in success
Date: 06/08/19 | Duration: 00:28:26
All listed companies in the UK with more than 250 people must now report the ratio between their CEO pay and the median pay of their employees. But will that make much difference to the widening gap, and are big, complex reward packages much of a motivator anyway?
In this podcast, our speakers discuss the existing models of executive pay and incentive plans, what motivates top earners and the importance of fairness in reward, as well as the future role of Remuneration Committees. We hear from Sandy Pepper, Professor of Management Practice at the London School of Economics, Charles Cotton, CIPD’s Senior Adviser Pay and Reward, and Julia Hanna of Verditer Consulting.
View the full podcast transcript
Philippa Lamb: Last month the Institute for Fiscal Studies proved that the pay gap between bosses and workers is widening. Average CEO pay among FTSE 100 companies was 145 times higher in 2017 than the salary of the average worker. Twenty years ago that multiplier was 47. Different organisations take wildly different positions on how senior bosses should be remunerated. In May, Julian Richer, Founder CEO of Richer Sounds, handed 60% of his business to his 500 employees citing ‘people before profits’. Over at housebuilder Persimmon, CEO Jeff Fairburn finally stepped down at Christmas after years of criticism about excessive pay at the company when his £75m bonus proved to be a step too far.
Now all companies in the UK with more than 250 people have to report the ratio between the CEO pay and the median pay of their employees. But will that make much difference and are big, complex reward packages much of a motivator anyway?
Joining me to discuss executive pay and the psychology of motivation, I'm joined by Sandy Pepper, Professor of Management Practice at the LSE; Charles Cotton, Senior Adviser Pay and Reward here at the CIPD and Julia Hanna of Verditer Consulting.
Sandy, we have been talking about the executive pay system and how it’s broken for years now, we’ve been making podcasts about it. But that gap between CEO pay and average worker pay - it keeps getting wider. Why aren’t things changing?
Sandy Pepper: So I think this is actually a little bit of basic economics. The pay of all employees, the labour market for all employees, is generally relatively efficient. There are lots of people in it. And so for an efficient market you need lots of components, reasonably homogenous products, lots of information, and in that way the market can establish the correct price.
PL: It self-corrects?
SP: It self-corrects. The labour market for senior executives is nothing like that. It’s a very imperfect market. The products, if you like, the senior executives, are not homogenous, they’re all very different and there is not lots of information – there's more than there used to be – but companies still don’t know the ins and outs of what their most senior executives are going to be capable of doing or not doing. So we don’t have a very efficient market and as a consequence of that, the pay, which is the price in a labour market, is not calculated correctly in senior executive reward markets.
PL: So Charles, CIPD has been looking at this, this year, the numbers. How much are CEOs, it’s FTSE 100 and 250 isn't it, how much are they being paid?
Charles Cotton: Well we’ve noticed that pay has been going up remorselessly since 2008 for FTSE 100 executives. Then from 2013 onwards, it’s kind of seesawed from year to year between a band of just around £4m at the top and about £3.5m at the bottom, so it’s been bouncing up and down between that band over the last few years.
PL: So not a huge range.
CC: No, but you must remember that over the same period pay for your typical employee still isn't back to where it was in real terms before the 2008 financial crisis. We’re seeing levels of quite high personal debt and the belief now that work isn't, as it used to be, a route out of poverty.
PL: So Julia, you've worked in-house. What impact does that thinking that Charles just described have on people throughout the organisation. It must be demotivating?
Julia Hanna: Oh absolutely. I think there was some CIPD research a few years ago that said something like 54% of employees felt that executive pay was excessive and that has a real impact on engagement levels, trust in corporate business, potentially productivity. Companies only have a finite amount of money to spend. The more they’re putting into executive pay, the less they’re putting into pay for other employees but also in investment in plant, in investment in people. And Charles mentioned work no longer being a route out of poverty. If there's not investment in people then their careers and roles can't grow. So it really does have a massive impact on engagement.
PL: Thinking about how CEOs are paid, I mean long-term incentive plans - they’re the norm really and have been the norm since the Greenbury Report. Would that be right?
SP: The first long-term incentive plans in the UK were introduced by British Telecom and the Prudential and Reuters just before or around the time of the Greenbury Report. But Greenbury established a norm.
PL: And it sounded like a good idea didn’t it. But you’re not a fan?
SP: It sounded like a good idea at the time. Indeed, I believed in them at the time and in my previous life I was involved in implementing them. But I have come to believe that long-term incentive plans are part of the problem, not part of the solution.
PL: Why is that?
SP: They’re very complex and they’re not very well understood either by the public generally and often by the people who participate in them.
PL: So for people who don’t deal in these things, can you just give us an idiot’s guide to what they might consist of?
SP: So a long-term incentive plan. If you were participating in a plan, you would be awarded some shares on day one, linked to the performance of your company in some way. So let’s say you were given 100 shares, they won't vest for at least three years, possibly longer. For them to vest, your company has to meet a series of financial performance targets. The effect of this is you received a very complex instrument that you find it difficult to value. In three years’ time who knows what the circumstances in the market might be. You mentioned Persimmon earlier, the Persimmon LTIP that was set up at a time before the government started to push lots of money to encourage house building, so the building firms benefitted hugely from an upsurge in the market.
PL: So it was widely perceived as unfair as well?
SP: Widely perceived as unfair, yeah. And it can go the other way, you can have very successful companies, companies performing very successfully, who have performance conditions that work against them. Maybe their metric is with a basket of other companies, maybe some of those companies are taken over during the year. That gives them apparently huge upside performance in terms of share price or total shareholder return and your company which has just been growing organically, doing the right thing, gets penalised because of a relative performance.
PL: So false comparisons.
PL: And thinking about podcasts we’ve made in this arena before and the complexity of executive pay packages, certainly it seemed from our interviews that a lot of CEOs don’t understand their own remuneration packages, they are so complex. And if they don’t understand them, it’s hard to see how they can really be much of a motivator.
JH: Yes absolutely. When working in-house, we do some changes to long-term incentive plans and people tend to want to participate because it’s a status symbol, particularly if it’s only open to certain echelons of the organisation, but if you actually ask people to explain it or to articulate the value that they’re getting, they would really struggle to do that.
PL: Thinking more widely about fairness and the appearance of fairness, the reality of fairness, the measures that are used to establish whether a CEO is actually making a difference in the organisation. Would it be fair to say they are reasonably narrow, as you say around how the competitor is doing, how the business is doing. Should they be wider? Should they be more about the well-being of the staff or eco issues? I mean is that something to do?
CC: Definitely. I mean at the moment how performance is defined is on a narrow range of financial metrics and we think, at the CIPD, that actually success should be defined more broadly looking at both the customer and the employee experience. We also think that focusing on one individual, as if the chief executive has personally achieved what all the individuals within the workforce have contributed to, is probably not correct.
PL: And demotivating in itself.
CC: And demotivating in itself. And also, as Sandy was talking about earlier, then the only way to reward these individuals is pushing huge amounts of money at them is probably not the best way of rewarding them and potentially demotivates the rest of the workforce. And there are other approaches as well as looking at improving the talent pipeline. You know, Sandy was talking about how restricted it is, at the moment we’re seeing various initiatives to get organisations to widen that, and encourage more women into senior management and ultimately into chief executive levels as well.
PL: What do you think the best options are Julia?
JH: I think it’s two-fold really. I think for the long-term incentive plans, if we are looking at it, I think the measures need to be different. I totally agree with Sandy.
PL: What sort of things would you like to see?
JH: I think if we’re looking at financial measures, they should be ones that the senior team can actually influence rather than, as Sandy described, things that are influenced by the market and things like that. I think that's the first thing. Secondly, agreeing with Charles as well, that the metrics need to be much, much wider. Economic, social, governance type metrics. The UN has published 17 sustainable development goals. Those sorts of things can be linked into, whether it’s long-term incentives, but executive pay as far as targets and goals are concerned.
PL: Harder to measure?
JH: Potentially. But I think that's down to good target setting at the beginning as opposed to trying to retrofit things at the end of the process. But I think things potentially are changing. Richard Walker who is the MD of Iceland was on BBC Question Time and he referred to the role of business changing, no longer there just to enrich shareholders. So I think there is an appetite for having broader metrics and understanding that it isn’t just all about the financials and that we define success in a much broader way.
PL: And I think there was a piece in the Wall Street Journal not long ago saying more companies are linking CEO reward to sustainability targets, so without wishing to diminish that aspiration in any way, there's a fashion element here isn't there of what plays well in the media and in PR terms about how you’re defining company performance?
SP: So if I can be a bit radical here?
PL: Please do.
SP: I think you use metrics to run businesses. You shouldn’t use metrics to decide how you pay people. CEOs are perfectly capable of working out what the most important thing for their company is at a particular time. And it changes hugely. The Persimmon issue - a long-term incentive plan was set up at a time when there was one set of market conditions which a few months later changed radically. So I think we have made the mistake of being on this search for the perfect metrics and I personally believe that you need metrics to run businesses, but we don’t need to tie pay to metrics. We can do pay in a different way.
PL: What do you think is the big motivator for CEOs if it’s not pay, because they say it’s not pay don’t they in surveys?
SP: They say it’s not pay. There is a long history of research into motivation that distinguishes between what the psychologists call intrinsic and extrinsic motivation. Another of my criticisms or critiques of the thinking about pay over the last 30 years is all the focus has been on extrinsic motivation and we haven’t given enough consideration to things like virtues and vision and all the things that really make us go to work. Once we’re beyond a certain point in terms of having sufficient money to support a lifestyle that we feel comfortable with, additional amounts of money don’t really motivate people, it’s other things.
JH: I’d agree. I think most senior managers, the executives that I deal with, actually want to do a good job. They want to do the right thing and we are in danger, particularly with the metrics and things like that, of actually defining success too narrowly.
PL: Yeah, I mean thinking about the level of pay and as you say alternate organisations, I do remember us saying in a previous podcast, we looked at some data that said CEOs weren’t that bothered about how much they were paid as long as it was about what other CEOs were paid in that kind of arena, and it was more about parity than the number, which I thought was really interesting.
SP: So this is fascinating, and it is all about fairness. I remember a debate I had with the CEO of one company and he said, ‘The only thing that matters to me is that I'm paid more than my brother,’ and his brother was a very successful entrepreneur, had set his own company up. You know, perfectly humanly understandably this CEO’s measure of success was how well he was remunerated in comparison with his particular referent which was his brother. Now in other conversations with other CEOs they all had a referent group, and if it was a mining company it was other mining companies, insurance it was other insurance companies. What they wanted to feel was that they were paid, in inverted commas, fairly, in comparison with people in their referent groups.
PL: That's interesting because I think, clearly, they understand the issue about fairness don’t they. But, you know, we have this pay ratio regulatory system now so it will be clearly understood about how much the CEO is getting versus most of the other people. There's a fairness issue there too but that doesn’t seem to be landing in the say way does it, why isn't that impacting more? Do you think it will?
SP: Because the comparison is with your referent group. It isn't with the population generally.
PL: But is that the psychology that needs to shift?
SP: Possibly, but this is not an easy thing to do.
PL: So that is the task for Remuneration Committees isn't it, Julia? Charles? So are they thinking too narrowly?
CC: Well I think they’re perhaps as a constitute to just focusing on the chief executive and we would like a broader consideration of not only just the chief executives but how reward is distributed throughout the organisation, and thinking about, well, how can we reward employees more fairly for their contributions. So can we give them a slice of the profits through a profit share scheme? Can we give a slice of the profits through an employee share ownership programme? And looking at it from a governance perspective should we take into consideration what employees are feeling about executive remuneration within the organisation? How can we take that on board as well, as well as talking to executives, talking about actually how would you like to get rewarded? Would you like smaller but potentially simpler and more immediate rewards than the current arrangement that you have at the moment?
PL: Well, Julia, you deal with RemCos. Do they think like that? I'm guessing they don’t.
JH: Not all! I will be honest. However I think again, with the new Corporate Governance Code, I think two things are going to happen. One is they’ve got a wider and a broader remit so they need to start thinking about how the executive pay aligns with the rest of the organisation. So I think that's going to be very interesting to see how that pans out. And we’ve certainly seen a huge increase in requests for Remuneration Committee training since January, since the new regulations came in. So I think there are some organisations that are taking the broader thing very seriously. I think as well the CEO pay ratios, some organisations will treat them as a compliance issue, a tick box issue. Others, there's the opportunity to use it as a catalyst for change. There's no right answer to these things, it depends on your sector and all of those kinds of things but just putting it out in the public domain will mean that it sits on the board’s agenda and the RemCo’s agenda very, very clearly because obviously there's reputation. The media will be all over this when they start to get published, in exactly the same way as they have done with the gender pay gap.
PL: Yes, and the idea of it broadening the remit of the RemCos seems like step one doesn’t it, because I was thinking about the layer down from CEO. We always talk about CEO pay but looking at the latest data I've got, it’s FTSE 100 companies, there's over 1,300 people in those companies who are earning nearly £1m a year each, so that's a significant number isn't it? And should we be widening the discussion and getting away from this idea of a handful of people at the very top and thinking right across. It sounds like that's what you’re saying?
CC: Yes, I mean I think it’s important. At the moment maybe a lot of attention, and perhaps justifiably, has been focused on the individual at the top, the CEO, though in many instances they may not be the highest earner in the organisation. So I think it’s only fair that we should be looking as well at what about the level just below? What are these individuals doing to justify this amount of money? How is it being distributed in terms of long-term incentives or increasingly there's a focus now on the benefits, especially pensions and whether those are fair compared to what the rest of the workforce is getting. But I think the overarching focus within an organisation should be on the financial well-being of its employees and what are we doing to promote that?
PL: Is employee ownership going to become more of a thing?
SP: I think we’ve been talking about this for a long time. Again in my younger and more idealistic days, I thought employee share ownership was a fantastic concept and should be encouraged. Today I'm afraid I'm not particularly persuaded…
PL: What that it’s a good idea?
SP: …that it’s a good idea.
PL: Why not?
SP: Well, the classic example I suppose is Enron whereby employees had so much of their personal wealth caught up in shares in the company that they worked for, when the company went bust they lost everything.
PL: It works for John Lewis though doesn’t it?
SP: Yeah but they don’t have shares…
SP: …that's different. Well, they don’t really have ownership do they. I mean they’re called partners but the company’s owned by a trust. I mean, sure John Lewis…
PL: They have a voice don’t they?
SP: They have a voice. I don't think the voice constitutes ownership. I don't think if you talk to somebody on the shop floor at John Lewis they'd say they owned part of the company. But they certainly have a voice. John Lewis is a delightful example but it’s also pretty unique in terms of its structure and its constitution and its values.
PL: So do you think we’ll see more, Charles?
CC: Well in this knowledge, and I suppose service and an innovation-based, economy, success is a collective endeavour so you would expect more focus on team rewards and participation and information sharing and voice coming up and down the organisation. So all those reward practices and wider people management practices that support this - obviously that's going to have a big impact. And those organisations that aren’t able to do that will suffer in the marketplace. It’s just keeping yourself abreast of latest thinking, latest developments and, unfortunately in reward we’re often looking at theories that were developed many decades ago, you know Maslow and Hertzberg back in the 40s and 50s, when it comes to executive pay, principal agency theory which was developed back in the 70s. So it’s important that Remuneration Committees start thinking, well what’s the latest evidence out there? What’s that showing? Should we start rethinking or reframing how we reward, not only just the executives but everybody throughout the organisation?
PL: Let’s talk about organisations that feel they want to do things, but the anxiety’s always going to be the disadvantage of being a first time mover, isn't it Julia? Do you encounter this?
JH: Yes certainly. The conversation we have with Remuneration Committees is all about what is everybody else doing.
PL: They like the idea but they don’t want to be first.
JH: Yes absolutely. And I think it’s we always counter and say well actually it almost doesn’t matter what everybody else is doing, you need to work out what your purpose and vision is for your business, what your strategy is and then the organisation structure and the people structure and the pay structures and things like that should follow. And I agree with Sandy the point with regard to equity, sometimes it’s about setting out what fairness means in our organisation and this therefore is how the reward fits in with that and then people will either sign up to that if that works for their own culture and their own thinking, or they’ll decide that the organisation’s not right for them and potentially go elsewhere. But it’s about being clear and I think part of the problem within the reward circle is that we’re not necessarily clear, we don’t like talking about things, it’s a bit of a dark art and employees really don’t understand how their pay is set, how to progress their pay. Whereas if we were actually a bit clearer and a bit more transparent about all these things, it might actually help.
PL: That is a really interesting point.
SP: I wrote a piece for Harvard Business Review a couple of years ago on this whole topic of the psychology of incentives and somewhere along the line in the discussion they said, ‘So where’s the case study?’ and I said, ‘Well I don’t have a case study yet because nobody’s done it.’ Now interestingly somebody has now done it, which is the Weir Group. So we do now have the first signs of a company changing the way it does senior executive reward, actually reducing the potential rewards for top executives quite substantially but paying them in a way that has a longer term focus and is more certain.
PL: Is it possible for you to give us a short summary of how they’re doing it?
SP: Yeah, so they had a classic long-term incentive plan type thing with big targets, lots of complex metrics and a new chair of the Remuneration Committee, Clare Chapman, who has been involved amongst other things in a piece of research called The Purposeful Company, a report, and is very much minded that pay arrangements need to change. So she worked with the CEO and with various advisers to replace their long-term incentive plan with a restricted share plan. So I mean still not quite as simple as I would have liked it to be, but nevertheless the executives got shares, they had no performance targets, just as long as they stayed in place over three, four, five, six, seven years they got the benefits of ownership. So much more certain than long-term incentive plans. And they reduced the total rewards that were payable under this plan very substantially. I think they cut the long-term bonus element by about 50%.
PL: Would you have said yes to that, Julia?
JH: Yes, I think I would. I think definitely. Certainly, the long-term incentive side of things has ratcheted up because of the uncertainty of the payments. And I think receiving something now as opposed to another sum at some potential future date maybe, makes sense. And I think that having that certainty and actually making things simpler makes a massive amount of difference.
PL: Charles, I know CIPD’s bringing out a report on executive pay shortly. As I understand it, part of that involves you’d like to rebrand RemCos entirely and call them something entirely different and make them work entirely differently?
CC: We would like organisations to think about repurposing their Remuneration Committees and potentially even changing their names.
CC: Perhaps People and Organisational Committees, or just to basically give the impetus to think about reward, remuneration, more widely within the organisation, saying: Well, this is what we’re giving the chief executive, how does that relate to the others in the workforce? Why are we rewarding people in this way? What are the skills, behaviours, expectations we want from these individuals.
PL: So we need to wrap this up but before we do I just want to ask you two whether you feel that sounds like the way forward?
SP: Yeah, I've been interested in pay for a long time and I've done research in the executive pay area for quite a long time, but in the last few years my focus has been much more about the purpose of companies and this phrase ‘people and organisation’ which I really like, because I think actually pay is a presenting problem. If you go to a psychotherapist with a sore back and he says, ‘Actually the problem’s got something to do with the way you were brought up,’ - I'm being slightly glib - but I mean this idea actually that the presenting problem is not the real problem, and I think in a sense the real issue that our companies face is a much broader one than how the pay of the top people is calculated.
PL: And Julia talked about the zeitgeist earlier. Do you think the zeitgeist is finally right now for organisations to take this thinking on board?
JH: I think so, and I think there's a definite opportunity for HR to really push the agenda on this. And I agree it isn't just about pay. There's a whole host of reasons why we all come to work. Pay clearly has a role to play, but actually widening the remit and actually looking, not only top to bottom in the organisation, but also more widely than the pay, bonus and share plans, and thinking about all of the other reward elements, intrinsic and extrinsic, will have a definite impact.
PL: Well thanks to all of you: Charles Cotton, Professor Sandy Pepper and Julia Hanna. There is more on the website as always. And look out for that new CIPD report on executive pay soon. Thanks for listening.
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