Why does CEO pay get such a bad press?

Executive pay is never far from the headlines. Given a number of high-profile corporate governance failures and the stagnation of wages for the general population, it is little surprise that the debate is high on the agenda again.

Where headlines go, politicians are bound to follow, and it is fair to say they are more concerned with other people’s pay than ever before. Rightly, some political intervention is aimed at improving the circumstances of definable groups – the complex mechanism of the minimum wage and the requirement for large organisations to publish their gender pay gaps and work towards narrowing them, being positive examples. 

What is interesting with executive pay, is that media and political intervention is not motivated in any clear way at improving the position of anybody, but instead attacks the moral basis of what is perceived as the over generous remuneration that arises from the market economy, and then demanding it is curtailed. Criticism is often selective. Listed company executives are commonly in the firing line, but entrepreneurs (and football stars) are not. Political views have also shifted sharply from a cross party neutrality about acceptable high pay. 

In 1998, Labour Cabinet Minister Peter Mandelson was ‘intensely relaxed about people getting filthy rich (as long as they pay their taxes)’, whereas in 2018 Conservative Minister Caroline Nokes asserted that no one should get an annual salary over £1 million. 

To date, the key changes for UK quoted companies include mandatory disclosure of pay ratios between CEO and employees and the publishing of a narrative explaining any changes to that ratio from year to year setting them into context of pay across the workforce. 

And on the horizon? There have been pushes from the Opposition to give employees a direct say in executive pay in listed companies through worker representation on boards, and Rachel Reeves, Chair of the Commons’ Business Committee, has argued that excessive executive pay undermines public trust in business while average worker pay is squeezed, and that Government should take tougher measures on pay if boards and RemCos fail to exercise moderation on awarding executive pay.

There is little doubt that executive pay is an important issue, and the prevailing wind with politicians, media and public is reduction. However, beyond the headlines what are the wider arguments?

The indictment

Central to the indictment is that executive pay has risen far faster than the average wage in recent decades without any corresponding increase in company performance. The argument that international competition for rare talent justifies the high CEO pay is dismissed on the basis that most companies promote from within and analysis that suggests long established businesses (as opposed to entrepreneurial start-ups) succeed on established systems rather than the singular abilities of the incumbent CEO. 

There are suggestions that most shareholders would like to see more modest levels of executive pay, but are too far removed from the operations of corporations by virtue of the financial advisors, asset managers and pension funds that hold shares on their behalf; intermediaries that are highly paid themselves and unlikely to take issue with generous pay. 

And of the RemCos that are required to be independent of the company’s management structure? These committees, it is argued, are from the same mould as the executives they reward – generously paid, from similar backgrounds and often holding or having held executive posts on other boards. 

The increasing use of Long Term Incentive Plans is seen as driving the vast increase of CEO pay in recent years despite the intention that LTIPs award varying levels of reward based on the company performance over the coming 3- 5 year period. Proponents of reform claim that the near universal use of LTIPs is undermining corporate governance; the fact that LTIPs pay out for almost every CEO almost every year despite performance is indicative of the problem given that they are meant to be awarded for exceptional leadership.

Criticism is often selective.

The case for the defence

Central to the defence is that the executive pay agenda is largely political and based on arguments that are fundamentally flawed. Government is concerned with public opinion, Institutional shareholders are nervous of being accused of poor governance, and newspapers want to sell copy. 

Journalists and then politicians have been convinced by flawed analysis, and then repeated the myths that executive pay is out of control and there being a lack of correlation between executive pay and listed company performance.

A problem with the reporting on executive pay are the headline grabbing surveys and analysis giving rise to vast increases in CEO mean pay. The High Pay Centre ran an analysis that gave CEO mean pay an increase of 23%, which was grossly distorted by excessive pay in a few companies. Further into the report was an admission that the median increase was 6%. 

Are CEOs genuinely unaccountable for poor performance?

This theme is generally based on the view that salaries and bonuses are insensitive to company performance. While there may be some truth to this, salaries and bonuses are only a small part of the incentive.

The biggest component is stock and options holdings, and one has to consider not just stock options granted this year but also the stock and options granted in previous years. The key then is not pay sensitivity, but a CEO’s wealth sensitivity to performance. PwC has calculated that a 10% drop in share price equates to a drop of £650,000 in wealth for the median FTSE 100 CEO.

Are shareholders too small to be heard and powerless to influence CEO pay?

There are strong arguments to suggest this is the case, but what happens when shareholders can dictate what happens in a corporation? Evidence suggests that when private equity firms or hedge funds take large stakes in a firm they are not afraid to make huge changes to improve performance, increase innovation and, if needed, even fire the CEO. However, they rarely cut the CEO’s pay.

Journalists and then politicians have been convinced by flawed analysis, and then repeated the myths that executive pay is out of control and there being a lack of correlation between executive pay and listed company performance.

Worker representation on boards

The case for worker representation on supervisory boards is contentious. Will this herald the executive pay restraint that is being called for? A common belief in the UK is that high pay is generally a US and UK phenomenon. 

A Bloomberg report in 2016, looked at 25 of the largest economies and compared CEO pay of listed companies. To little surprise, the US came out on top at 2.6 times the average (average CEO pay $16.95m on the S&P 500), then Switzerland

at 1.6 times and then the UK at an average CEO pay of $9.61m for CEOs from the FTSE 100. Surprisingly, Germany came in at 7th with average pay for CEOs of companies listed on the DAX 30 of $8.36m.

Germany’s high ranking comes as a shock given the perception that German firms are an example of transparency and fairness, largely due to being subject to a supervisory board with worker representation. However, German firms are still open to the world, externally focussed, and competing on a global market to attract and retain the best CEO talent. 

There is a strong case that perhaps it is worth corporations paying the top salary to secure the best talent for the role. The median value of a FTSE 100 firm is approximately £9bn. If a CEO contributes only 1% more than the next best CEO, that contribution is worth £90bn (much higher than the median £4m salary).

So, is reform warranted?

We have looked at various arguments central to both sides of the debate and, beyond the facts, a lot of the opinions are subjective such as should pay be driven by market efficiency or social Equality.

Presented with the same statistics we can still find difference in how to interpret them, but perhaps we should start with the facts rather than the headlines. Has this done more to create resentment among the population than the actual levels of pay themselves? Will naming and shaming companies on the basis of the pay ratios work or lead to misleading comparisons? 

Maybe reform is warranted, but perhaps we should move away from the mentality of pay reduction for the sake of it and instead move towards the mindset of value creation and work towards incentivising CEOs to keep bringing everyone else’s pay up.