The High Pay Centre is an independent, non-party think tank focused on pay at the top of the income scale. Their report suggests that there’s an increasing level of concern in the investor community and among employees and customers of businesses that corporations pay – and are seen to pay – their Chief Executives many times more than the salaries of their employees.
But there’s more to this than just the numbers. Recent press reporting has highlighted an element of social justice that’s being championed by the High Pay Centre and other influential consultancies such as Pensions & Investment Research Consultants Ltd. PIRC recently agitated for changes to the remuneration package at JD Sports and before that they complained about Tesco’s salary packages.
If the numbers and sentiment seem to be heading in the wrong direction for CEOs, it might be worth checking recent academic research – where there’s further bad news. A study conducted by Perdue University in 2009 found a negative correlation between high pay and corporate performance:
We find evidence that industry and size adjusted CEO pay is negatively related to future shareholder wealth changes for periods up to five years after sorting on pay. For example, firms that pay their CEOs in the top ten per cent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs.
We clearly have a problem: the evidence suggests that paying CEOs vast remuneration packages can reduce corporate earnings, employees and investors show little appetite for high levels of executive compensation relative to their own and they are prepared to make their voice heard at shareholder meetings.
There is one final and perhaps most compelling reason to get this right in 2019.
New corporate governance regulations under the Companies Act 2006, come into force on 1 January 2019, requiring UK listed companies with more than 250 UK employees to report annually on the pay gap between their chief executive and their average UK worker.
Businesses will have to state, in their directors’ remuneration report, the pay gap between their CEO and a representative employee from the:
- 25th pay percentile
- median pay band
- or 75th pay percentile
Companies must choose one of the three options for calculating the pay gap; they must account for their choice in the report and make it clear what action they’ve taken to improve employee engagement and consultation.
Whether you feel compelled for social justice reasons, investor and customer relations or perhaps just the research, the change in the law means that for many the earnings of the CEO is going to come under scrutiny next year.
So, what might a board do to better understand and set the salary of a CEO? Most would see the wisdom in having a set of well-argued points supported by accurate earnings data ahead of the inevitable press interest in earnings ratios in 2019.
The comprehensive High Pay Centres report highlights a number of principles for setting and reporting earnings for the coming year. They suggest:
- Rather than waiting for the pay ratio reporting requirement to come into force in 2019, companies should introduce it immediately, supported by a clear narrative.
- Companies should provide clearer information about wider pay distribution within their organisations.
- Remuneration committees and shareholders should place stronger emphasis on ensuring CEO reward is aligned with pay practices throughout the organisation.
- Remuneration committees should ensure that CEO performance is assessed by non-financial as well as financial measures, including investment in workforce training and development and indicators of employee satisfaction and well-being.
- HR professionals have a vital and critical role to play in influencing remuneration committees and must ensure that senior leaders receive and act on the insights from pay data, appreciating the various ways that reward can incentivise and affect behaviours and performance across the workforce.
It’s interesting to see these last two elements highlighting training, development, behavioural analysis and performance across the workforce. The changes to corporate governance requirements also stresses the need for employee engagement.
Cognisco and its partners can help your organisation both understand the changes to corporate governance and reporting requirements ahead of 2019. We can also help a board gain insight and assurance that business departments responsible for decision support and engagement highlighted in the new regulations are both competent and well informed in their decision making.