In her first few months as Prime Minister, Theresa May, has been strong in her rhetoric in clamping down on excesses in big business, saying she wants to improve corporate governance through initiatives such as putting workers on company boards. She has also spoken out against excessive executive pay. In this article, Charles Cotton discusses CIPD research on the impact of spiralling executive pay on the productivity of the workforce below. He suggests that, for a start, organisations can promote transparency by publishing the ratio between executive pay and the average employee, so as to start discussions as to what the packages paid to senior executives should really entail.

Just before Christmas 2015, the CIPD published findings from a report on CEO remuneration practices in large UK-listed firms. It found that pay had reached a crisis point, with large swathes of the workforce feeling demotivated by a missing link between senior executive pay and performance.

In response to our findings, the CIPD called on employers to adopt simpler and more transparent pay practices. Rather than having large bonuses and incentives, linked to a variety of complex financial measures and subject to deferral and clawback, we suggested smaller, simpler and more immediate rewards. Instead of focusing on financial metrics, variable pay would also be linked to people and customer measures.

Amongst other suggestions, we recommended the Government required firms to publish the gap between the pay of CEO and the median full-time employee. This was not to name and shame employers, but to encourage a debate within the firm and between it and its investors about what it was rewarding (in terms of behaviours, attitudes, experiences and skills) as well as why and how. For instance, how does the long-term incentive support the mission, vision and culture of the firm?

There was extensive media coverage of our report, and our findings found traction with a variety of politicians. For instance, the Scottish Conservative leader, Ruth Davidson mentioned us in a speech, and were cited in a report on exec pay by the MP Chris Philip.

During her speech announcing her leadership bid for the Conservative Party, now Prime Minister Theresa May said:

'The FTSE, for example, is trading at about the same level as it was eighteen years ago and it is nearly ten per cent below its high peak. Yet in the same time period executive pay has more than trebled and there is an irrational, unhealthy and growing gap between what these companies pay their workers and what they pay their bosses.

'So as part of the changes I want to make to corporate governance, I want to make shareholder votes on corporate pay not just advisory but binding. I want to see more transparency, including the full disclosure of bonus targets and the publication of “pay multiple” data: that is, the ratio between the CEO’s pay and the average company worker’s pay. And I want to simplify the way bonuses are paid so that the bosses’ incentives are better aligned with the long-term interests of the company and its shareholders.'

There's been some criticism of publishing a pay ratio. For instance, some banks will have a smaller ratio than some retail chains. Similarly, businesses that franchises their operations (such as hotels or restaurants) will have lower ratios than those that own and manage their operations themselves.

However, that misses the point.

With our recommendations, we’re arguing that such ratios are starting point for a discussion about reward policy throughout the organisation and would be metric amongst other people and business measures. Given that employers will have to collect similar information for gender pay gap reporting, we thought that publishing the pay gap between the CEO and the median full-time employee would be a good starting point.

There are other measures that should be explored, such as the gap between CEO pay and the median pay of: the senior management team; all employees of the organisation; and all those working for the firm, including such contract staff as cleaners. As well as looking at the size of the ratio, it would also be useful (and potentially more meaningful) to explore how and why these ratios have changed over time.

Of course, there are other human capital metrics that can be used to assess organisational and CEO performance in addition to the pay gap, from the amount of shareholder value generated as a proportion of CEO pay to the cost of employee absenteeism and turnover.

During her speech, May also said:

'I want to see changes in the way that big business is governed. The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions, think about the long-term and defend the interests of shareholders. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough. So if I’m Prime Minister, we’re going to change that system – and we’re going to have not just consumers represented on company boards, but employees as well'.

While employee representation on boards has worked (to varying degrees) in such countries as Germany and Denmark, as HR practitioners we know that it is not enough to import a practice from another organisation. For the initiative to be successful, you also need to create an eco-system to support it.

For instance, how do we encourage employees to take part in the election of an employee board representatives? How do we best encourage employees to stand for such roles? What training and development is required so that these representatives are able to operate effectively at board level and who is best placed to provide this support? Should such representatives get paid time-off in connection with their board duties?

The CIPD plans to play an active role in the discussion of these and other issues when the Government brings forward its ideas on pay ratios and employee representatives, and is currently putting together its submission to the Business, Innovation and Skills Select Committee’s inquiry into corporate governance.

About the author

Charles Cotton, Senior Performance and Reward Adviser

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.

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