When CEO pay costs a packet
How do you halt spiralling remuneration for chief execs? Angus McCrone considers the conundrum.
Imagine a sector with four leading companies. Each adopts an executive pay regime that involves a remuneration committee of non-executive directors, the use of external remuneration consultants, and a policy of rewarding its chief executive in the top quartile for that industry. The CEOs of the four companies in the year before the adoption of this regime are paid respectively £800,000, £700,000, £600,000 and £500,000.
The logical result would be that average chief executive pay in the sector would increase by at least 23% in the first year, as the lower-paying firms caught up. In the second year, all four companies would find they were in fact not paying top quartile at all, but only average pay for the industry and would, therefore, look at further increases beyond £800,000. And so the merry-go-round would spin, year in, year out.
Okay, so I have oversimplified enormously. Remuneration committees are not that robotic. On the other hand, I have left out other elements of executive pay, including share options, bonuses and pensions. I have omitted the likelihood of one or two of the four companies appointing a new chief exec in that time, and the role of executive headhunters in pushing up pay for new hires.
The only substantive thing that has changed on executive pay in the last two decades has been the number of zeros.
Back in the 1990s, there was a storm of media and political criticism aimed at privatised utilities for paying chief execs salaries of a few hundred thousand a year. In 2016, you need to be paid the sums awarded to the likes of Sir Martin Sorrell of WPP (£7.6m in salary and £62.8m in shares under a long-term incentive plan) or Bob Dudley of BP ($19.6m, up 20% in a year of record losses at the company) to attract the same negative attention.
The average CEO of a FTSE 100 company earned 183 times the UK average employee wage in 2015, up from 50 to 60 times in the late 1990s, according to the High Pay Centre.
Attempts to address the issue
So far, attempts to slow down the executive pay spiral have failed. The authorities have increased the amount of disclosure that has to be made in annual reports. The results are prodigious, with WPP, for instance, devoting 32 pages to the topic in the “How we behave and how we’re rewarded” section of its 2015 report.
They will run into the problem that executive pay, like footballers’ salaries, is set in the context of an international market, not a national one.
Shareholders get to vote on directors’ salaries, but the problem is that many investors see high pay for a handful of board members as a relatively small cost compared with the overall bottom line of a company – therefore not really worth causing a fuss about. Only in the most conspicuous cases do investors dig in their heels.
It would be a big ask to expect investors to focus on the wider social contract. Nevertheless, it is surely the case that political parties that allow the liberal free market system to run stand a better chance if that system is not seen to be rigged in favour of the few, while parties that threaten aspects of that system, such as free trade, international labour mobility and competitive tax rates, should do well if the gap widens between the rich and the rest.
There will be further attempts to address the issue. They will run into the problem that executive pay, like footballers’ salaries, is set in the context of an international market, not a national one. Crack down too clumsily on director remuneration in one country such as the UK, possibly by legislating salary caps or by introducing punitive marginal income tax rates, and the best managers will go abroad. Either that, or they will re-domicile UK companies into overseas jurisdictions that are not so fussy.
Nevertheless, we appear to be in a period when new ideas stand a chance of being taken up. One is for legislation on the maximum multiple of average employee earnings in a company that top executives (adjusted according to size of company) can earn without that firm incurring some sort of penalty, perhaps in the form of higher corporation tax.
A second is for executive pay to become one of the main focuses of the environment, social and governance (ESG) movement. Funds with ESG mandates would screen out stocks that perform poorly on pay criteria, leading to pressure for change.
The executive pay spiral may not go on indefinitely.
This article is from the June 2016 edition of CA magazine.