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18 June 2015

The head of a big company now makes more in a day than a worker on the minimum wage earns in a year

Soaring executive pay would be more ­justifiable if it reflected companies’ results. Yet the High Pay Centre report argues that this is not the case.

By Xan Rice

Cedric the pig enjoyed its moment of fame 20 years ago. The GMB trade union took the hefty hog to the annual general meeting of British Gas, whose then chief executive, Cedric Brown, had been granted a 71 per cent increase in pay and benefits, including a £475,000 salary: around £800,000 in today’s money.

Though the stunt failed (Brown kept his cash), the outcry over his package and other instances of excessive pay for bosses led to reforms in corporate governance. Two main principles for executive compensation were established. First, levels of pay should be set by remuneration committees that include independent non-executive directors. Second, earnings should be linked to the company’s long-term performance. Besides a salary, a typical chief executive’s package has an annual bonus and a long-term incentive plan (LTIP).

The result of the changes has been a huge surge in pay. A report by the High Pay Centre think tank in May showed that in the late 1990s the average FTSE-100 CEO took home roughly £1m. In 2014, that figure was £5m. Each of these bosses now earns roughly £20,000 every working day: one and a half times as much as a minimum-wage, 40-hours-a-week worker makes in a year.

Soaring executive pay would be more ­justifiable if it reflected companies’ results. Yet the High Pay Centre report argues that this is not the case. Between 2000 and 2013, bonus payments at the UK’s top 350 listed companies increased at twice the rate of earnings per share and company profits, two of the main metrics used to compute payouts. For LTIPs, it was even worse: little more than a quarter of the annual change in payments to executives could be attributed to a rise in earnings per share or total shareholder return in any year in the ­decade to 2013. “The net result is that CEO pay growth has dramatically outpaced pay increases across the wider economy, without any corresponding increase in company performance,” the report concludes.

Other data confirms the ever-widening pay gap between bosses and the rest of the workforce – not just the lowest-paid. It is a trend that is fuelling the debate about the “1 per cent” and inequality. The research group Incomes Data Services recently calculated that a FTSE-100 chief executive is paid 120 times more than an average full-time employee, up from 47 times in 2000. Compare this to the ratio of 20:1 that the American management consultant and writer Peter Drucker once said was the limit before a firm experienced employee resentment and decreased morale, or the paper, published last year by Chulalongkorn University’s Sorapop Kiatpongsan and Harvard Business School’s Michael I Norton, which showed that Britons thought the “ideal pay ratio” for chief executives to unskilled workers was 5.3:1.

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So, it is little surprise that people from across all sectors of business agree that the current model of executive compensation is broken. At one end of the spectrum is the TUC, which argues that the concept of performance-related pay is fatally flawed because it is impossible to measure fairly an individual’s impact on a large company. At the other end is the Institute of Directors, whose opinion may be even more damning, considering its status as the “independent association of business leaders”.

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The IoD’s director general, Simon Walker, said at the launch of the High Pay Centre report that “routine excessive pay has become too common in Britain” and that there is “a strong case for wholesale reform”. Even those who helped force through the corporate governance changes in the 1990s concede that the system has not worked as intended. David Pitt-Watson, who led the shareholder engagement activity at Hermes Investment Management, which manages £30bn, and who is now an executive fellow at London Business School, told me: “It is a very big problem that we can observe little correlation between company success and high pay.”

Why has it gone so wrong? Remuneration committees, whose members may be independent but are also often part of the high-pay club, must take some of the blame. Large shareholders, too. As in Cedric the pig’s time, protests from minority shareholders have little effect if the biggest stakeholders – the handsomely paid fund managers who hold our pension money – do nothing. Last year, a majority of shareholders in only one FTSE-100 company – Burberry, whose new boss, Christopher Bailey, had received shares worth nearly £20m and a pay packet of up to £10m a year – voted down a chief executive’s pay.

Besides wasting shareholders’ money, excessive performance-related ­compensation can damage a company’s prospects – and the economy. Many LTIPs pay out after three years, which encourages executives to push up profits hastily and, as a result, to limit investment that would yield benefits in the longer term, according to the economist Andrew Smithers. This, he believes, is why the UK’s labour productivity is so poor compared to that of other G7 countries.

So what can be done? Among the High Pay Centre’s recommendations are abolishing LTIPs, broadening the range of company-specific targets used to calculate bonuses and improving diversity on remuneration committees. Pitt-Watson’s suggestion is even more radical.

“Should we not rather be saying: let’s give you a good salary and a ‘normal’ bonus of 15 or 20 per cent, rather than one of five or six times the salary? Surely we want to create a society where the CEO is a respected person and acts in the company’s best interest, without the need of some huge payment to ensure they are doing their job well?”

Xan Rice is features editor of the New Statesman