Long reads

Will ratios fix executive pay?

27 Sep 2017 By Hayley Kirton

New corporate governance rules could see CEO salaries compared to average workers’ – but not everyone is in favour

The average pay of a FTSE 100 chief executive has rocketed from around £1m in 1998 to more than £4m today, according to figures cited in the Department for Business, Energy and Industrial Strategy’s (BEIS) long-awaited consultation response on corporate governance, which was published at the end of August.

While that figure will provoke consternation in some and resignation in others, there is a sense that structural changes are afoot in corporate governance, including the reporting of pay ratios between chief executives and average employees by listed companies – which could in time be extended to other organisations. Given that the average ratio in 2016 was 129:1, according to research from the CIPD and the High Pay Centre, firms will have some explaining to do when figures are published.

The consultation itself has been long in the making. Since 2013, listed companies have been required to give a single-figure total for their executives’ annual pay, bringing together elements such as pensions, bonuses and share awards into a single number that can be easily reviewed, while shareholders have had a binding vote on remuneration policies – the methodology that sets out how executives’ pay packets will be calculated.

However, the BEIS noted that a handful of companies were still persistently flouting their shareholders’ wishes on top-dog pay and the remuneration committees responsible for setting executive pay had little incentive to take into account the wages of the wider workforce. Here’s what you need to know about what happens next.

Will we all have to report pay ratios?

It’s possible. The BEIS has proposed introducing new laws requiring listed companies to report annually on the ratio between their CEOs’ pay and their average worker’s pay, providing details of why that ratio has changed year-on-year and clearer explanations of their remuneration policies, including clarifications of complicated share-based awards. The government paper concluded that providing such ratios would create “a valuable and dynamic reference point” to help companies explain boardroom pay within the context of their overall business. The requirement is expected to be in force by June 2018.

“Not much will change at first,” says Stefan Stern, director at the High Pay Centre. “But gradually and over the medium term, I think pay ratios will make their presence felt.”

What is the likely impact?

Consultation respondents who favoured pay ratio reporting said it would give companies a new tool to explain their approach to executive pay, while others felt it might incentivise firms to spread reward more evenly among their workforce.

Experts are optimistic. “We need to see fairer ratios between chief executive and average pay, as well as stronger remuneration committees that make sure executive pay packages are based on long-term evaluation of performance,” says Patrick Woodman, head of research and advocacy for the Chartered Management Institute. “High-profile cases of runaway executive pay and ‘rewards for failure’ have broken down trust in business. Greater transparency about executive pay will help drive change.”

Charles Cotton, reward and performance adviser at the CIPD, says: “You would hope it would encourage dialogue within the organisation and between the organisation and its stakeholders about what’s been awarded and why, when and how.”

Is everyone in favour of ratios?

Not entirely. Some of those responding to the consultation pointed out that it could be misleading if people attempted to compare pay ratios across different companies and sectors, particularly if no further explanation for the figure was provided. “A supermarket group, for example, would have a significantly wider pay ratio than an investment bank, because of a prevalence of low-paid workers in the former, yet the CEO roles might be equally demanding,” the white paper read.

Andrew Kakabadse, professor of governance and leadership at Henley Business School, slams the publishing of pay ratios as “a waste of time”, adding that too much data will likely distract the board from focusing on the issue of stewardship: “What we should be doing in the boardroom is building trust... this report is going to detract from that and just deal with more statistics so trust will be eroded further.”

Cotton says he would like chief executive-to-average-staff pay ratios to be one of a range of figures large firms provide about their reward policies. Other data points could include pay ratios between the highest-paid and lowest-paid employees, employee turnover figures and investment in training.

Cotton also notes that HR departments dreading an influx of complaints about the boss’s salary should relax, as employees generally accept that chief executives get paid significantly more than them. “I think where the questions will arise is how much of the extra money is down to performance,” he says. “The evidence indicates that CEO pay goes up quite significantly when performance goes up. However, when a firm’s performance drops, CEO pay doesn’t fall by that much.”

What else was in the recommendations?

Although the BEIS also asked if there would be any support for requiring companies to stick to an upper threshold for executive pay and having to seek a binding vote from shareholders if they wished to exceed it, there was little appetite among consultation respondents for such a punitive measure.

The government has also proposed creating a name-and-shame list of companies where at least a fifth of investors voted down their executive pay packets. And it suggests introducing requirements for businesses above a certain size to provide more explanation of how they are taking their employees’ interests into account across their reward practices more broadly.

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