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The role of executive pay in promoting responsible business

24 March 2017

Executive pay is a thorny issue. Well-structured remuneration packages can help to ensure that companies are run responsibly for the benefit of shareholders, employees, customers, and wider society. However, when improperly designed, executive pay packages can encourage short-term and risky behaviour which dents public confidence in business.

Recent trends

There have been a number of initiatives in recent years targeted at promoting the effectiveness of executive pay as a corporate governance measure. These include the increasing use of long-term pay incentives, more robust shareholder oversight, and additional disclosure obligations designed to improve transparency. The latest set of reforms came into effect in 2013, giving shareholders of quoted companies a binding vote on pay policies at least once every three years and an annual advisory vote on actual pay awards made to directors under the approved policies.

However, the escalation in remuneration that has occurred over the same period has led many to question whether the reforms are working. The average total pay of FTSE 100 CEOs rose from c.£1m in 1998 to c.£4.3m in 2015, far outstripping growth in the FTSE 100 share index and the increase in average remuneration for other employees over the same period. In 1998, the ratio of average FTSE 100 CEO pay to average full-time employee pay was 47:1. This had increased to 132:1 by 2010 and stood at 128:1 in 2015.

Proposals for reform

Although most agree that the increasing size and design of current remuneration packages is a cause for concern, there is a lack of consensus on what any reform should look like and what it should seek to achieve. In November 2016, the Government published a Green Paper on Corporate Governance Reform which contained its latest proposals to strengthen big business whilst ensuring that it continues to command public confidence and respect. Executive pay is one of the Green Paper's three focus areas and the Government invited views on five key areas: (1) shareholder voting; (2) shareholder engagement on pay; (3) the role of remuneration committees; (4) pay disclosure; and (5) long-term pay incentives. The time for submitting responses to the Green Paper ended on 17 February 2017 and the Government is now in the process of analysing public feedback. Whether the proposals are capable of having any meaningful impact on this area has been a matter of much debate.

Take shareholder influence, for example. Although the proper regulation of executive pay is often perceived to be the responsibility of the company's owners, the evidence suggests that shareholders are only willing to exercise their powers of control in rare and extreme cases. Since the introduction of the 2013 reforms, remuneration reports and policies have been voted down in only a few instances and usually only when pay was drastically out of line with wider company performance. Many shareholders are declining to make use of their votes at all, with an average percentage turnout of 71% for FTSE 100 companies and of 62% for FTSE small cap companies. Any further voting rights on pay will be subject to the same problems of shareholder apathy and a general lack of willingness to influence the remuneration process.

A further question is whether companies ought to be required to publish executive-employee pay ratios comparing CEO pay to that in the wider workforce. Some consider that this would allow stakeholders to draw comparisons between executive pay across different companies and to judge how pay ratios have changed over time. However, others believe that pay ratios have the potential to create results which can be misunderstood by the public and others when taken out of context. For example, they can penalise companies that offer significant non-monetary benefits, and encourage outsourcing of lower paid work so as to exclude it from the equation. Some also cite the so-called 'Goldman-Waitrose' effect, whereby Goldman Sachs would be portrayed as a more equitable company than Waitrose because its employees are on average more highly paid.

Going forwards

The ultimate aim for businesses is to attract and retain top talent whilst ensuring that those individuals are motivated to achieve sustainable, long-term value creation for the company. Where there is a perception that ever more generous remuneration packages are necessary in order to achieve those objectives, we are unlikely to see any reversal in current pay trends, with or without reform.

All figures are extracted from "Corporate Governance Reform: Green Paper", Department for Business, Energy & Industrial Strategy, November 2016.