Executive pay

Does your business take a responsible approach to executive pay?

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Since the 1980s, executive pay has risen hugely, with recent figures putting the average pay of a FTSE 100 CEO at 190 times the income of an average UK worker. Whilst high pay has risen dramatically, wages for low and median workers have been rising at a much slower rate, increasing levels of pay inequality. Organisations such as the CIPD, the IoD and PwC have all criticised the current model of executive pay, and there have been instances of public backlash against what is perceived as excessively high pay. Executive pay was mentioned in the 2017 manifestos of all three major parties, all concerned with lowering levels.

High executive pay can be damaging for businesses for two primary reasons. Firstly, it can be bad for a business’ reputation in the eyes of the public, and secondly, there is evidence that high levels of pay inequality within the workforce are bad for staff morale and productivity. Some pay inequality is motivational, encouraging staff to work hard to be promoted, but according to research by the High Pay Centre, companies in which the highest paid member of staff earns over 24 times the lowest paid experience higher staff turnover, greater absenteeism and more frequent industrial action. Furthermore, there is mounting evidence that high pay inequality is damaging to society overall.

Whilst some argue that high pay is deserved because of the value highly experienced executives add to huge companies, executive pay has been increasing year on year. In their submission to the Department for Business, Energy and Industrial Strategy, the CIPD and High Pay Centre argue that these increases have surpassed the increase in company value, suggesting that pay is not in line with performance.

Levels of high pay are partly caused by methods of recruitment. Rather than promoting internally, some companies hire head-hunters to seek out senior staff from elsewhere, who are then promised pay increases to take on a new role. The nature of pay packages also exacerbates levels of high pay. Long term incentive plans have been criticised because this may, counterintuitively, encourage short-termism , and CEOs discount the value of delayed pay, and therefore negotiate a higher level of overall pay. Evidence also suggests that increasing the complexity of packages, with a mix of component parts and various incentives does not lead to lower levels of executive pay. Instead, CEOs are generally more willing to accept a lower yet simpler pay package. Incentives have been criticised, not because they don’t work, but rather that current practices encourage behaviours that are not aligned with company purpose. Suggestions on how to change this include basing performance on measures that aren’t purely financial.

Levels of executive pay are typically decided by remuneration committees. These have the potential to curb high executive pay, or reinforce the current trend. The TUC advocates that employees be included on these committees, making the committee accountable to the workforce and bringing a diversity of viewpoints. Further, such committees can be made more effective by ensuring that they are fully independent of executive staff, so that senior executives do not unduly influence discussions, or indeed make the final decision. Transparency over decisions and decision-making processes may also increase accountability. Additionally, shareholders have a role to play, and companies can restore public faith in the system of executive pay by having effective procedures in place to address and accommodate shareholder disapproval.

However, it has been argued that transparency over levels of executive pay may be exacerbating the problem. Research from PwC and the LSE suggest that disclosure of executive pay has provided opportunities for cross-comparisons from companies and executives, and a subsequent pay ratcheting to keep pace. Companies try to employ CEOs with higher salaries to improve their status, while CEOs themselves negotiate higher pay packages in order to be paid the same or higher than their peers at comparable companies. Indeed, research has suggested that whilst many CEOs are willing to be paid less money, they don’t want to paid less than their peers. This does not mean that transparency is wholly counterproductive. Rather, full transparency is part of a set of approaches that can assist in reforming executive pay, and extends to the full process of deciding executive pay packages.

The ratio between the highest paid and lowest paid members of an organisation has also been cited as a concern by unions, campaigners and politicians. When looking at pay ratios, sector and company size are important to bear in mind. A bank where everyone is highly paid is likely to have a lower ratio than a supermarket where most of the workers earn lower wages, even if the bank’s CEO is in fact paid more. Further, it should be noted, that a desire to keep pay ratios low may lead to companies ‘outsourcing’ low-paid work such as cleaning. On the other hand, highly paid individuals may work through ‘personal service companies’ receiving payment, rather than income. Ratios are therefore only valuable if they are provided within the context of the company, regarding its sector, size etc, and with full disclosure on how ratios were calculated, for example, if the ratios include contractors’ pay. Alone, publishing ratios does not resolve issues surrounding high executive pay, but it can play an important role in addressing them as part of a raft of possible solutions.

Bonus

A 'bonus' is anything over and above what is expected. It may be additional compensation given to an employee above his/her normal pay. A bonus can be used as a reward for achieving specific goals set by the company, or for dedication to the company, or as a dividend paid to executives and/or staff from funds created out of additional profits realised by the company. A ‘deferred bonus’ is an arrangement by which a proportion of a cash bonus is paid after a set period on condition that certain targets are met – such as the company remaining profitable.

Long Term Incentive Plan

A 'Long Term Incentive Plan' (LTIP) is designed to incentivise senior executives over a set period, typically three to five years. The LTIP generally attempts to tie executive pay to shareholder returns and/or to the comparable performance of direct competitors – known as ‘peer benchmarking’. A rising stock market will increase an equity-based compensation package because it inflates the value of assets and shares, regardless of other performance indicators.

Personal Service Company

A Personal Service Company (PSC) is company that sells the work of an individual or group of individuals, and which is owned and operated by that individual or group of individuals. The structure of a PSC disguises what essentially is employment as a client/contractor relationship instead (with associated avoidance of tax and other costs).

Profit sharing

'Profit sharing' refers to an incentive plan that provides direct or indirect payments to employees depending on the profitability of the business.

Remuneration committee

A 'remuneration committee' consists of non-executive directors and is charged with deciding on the pay and incentive schemes for executive directors.

Share option

A 'share option' gives the right, but not the obligation, to buy or sell a stock at an agreed-upon price within a certain period or on a specific date. In Europe, generally redeemed at the expiration date of the option.

Short Termism

'Short-termism' is the focus on short-term goals and projects at the expense of long term achievements and security.

Answering YES

All Businesses MUST

Describe their policies and practices in regard to executive pay

Describe the process that determines levels of executive pay, and any measures used to determine performance related pay

Explain whether or not pay ratios are calculated and if they are published (either highest paid:median pay, highest paid:lowest paid, or both)

Outline what pay packages of the senior executives include with reference to basic pay, and all additional rewards or remuneration such as annual bonuses, share options, pension, long term incentive plans, and if these are published

Explain if they employ contractors, freelancers etc, and describe policies regarding their pay

All Businesses MAY

State any philosophy or values which influence their approach to executive pay and pay ratios across the workforce

Set out any proposed future policies regarding remuneration

Describe any policies and practices regarding pay of staff, and whether these cover contractors, freelancers etc

Describe policies and practices regarding pay for other senior staff members

Describe whether and how employees are consulted over executive pay and ways employees can engage with decision making process and policies

Describe the ratio between executive pay and the national average wage, the living wage and the minimum wage

Describe any policies relating to pay ratios

Provide data on the rate of change of executive pay in relation to change in company value

Include the ratio of change in exec pay:change in average pay of whole workforce

Describe the criteria used to determine if bonuses are paid, and any targets, and how these are measured

Disclose whether the CEO, or other senior staff members, are paid partly or fully through Personal Service Companies, and if so, state the reasons

Describe if and how they influence others or campaign on responsible executive pay

Explain who is consulted in developing pay policy.

Give the business’s definition of ‘fair’, describe if and how they implement fairness in their pay policy

Describe process of dealing with shareholder opposition to pay levels

Answering NO

All Businesses MUST

Explain why they do not or cannot answer YES to this question, listing the business reasons, any mitigating circumstances or other reasons that apply

All Businesses MAY

List any practices that are relevant, but not sufficient to answer YES

Mention any future intentions regarding this issue

Answering NOT APPLICABLE

All Businesses MUST

State that they have no employees or contractors

All Businesses MAY

Disclose according to the guidelines for answering YES, or as close as possible, or otherwise demonstrate equivalent

DON'T KNOW is not a permissible answer to this question

Version 4

To receive a score of 'Excellent'

Responsible executive pay is fundamental to the business and rigorous policies and practices are in place

Examples of policy and practice which may support the EXCELLENT statement:

  1. Company has a statement of values or philosophy regarding pay
  2. Policies are in place regarding excessive executive pay, fair pay, and low pay, including contractors, freelancers etc, which are consistently and effectively implemented
  3. Performance regularly meets stated values and goals
  4. Levels of executive pay are lower than the average for comparable organisations
  5. Publicly states a single figure of annual executive pay and fully explains how it is structured
  6. Clearly outlines metrics used to measure performance related pay
  7. Is transparent on levels of pay, decision making process and metrics used
  8. Incentives used regarding executive pay are in line with company strategy and promote sustainable company performance
  9. Measures used to assess executive pay consider aspects in addition to financial measures
  10. Business requires/encourages high shareholding from Executive
  11. Business designs pay package to be long term, eg. Shares released in phases, release of equity is phased along defined time-scales, pays bonuses in shares
  12. States internal pay ratios and measures high pay against national living wage and minimum wage, and explains fully how these ratios are calculated
  13. Pay ratios between executives and low and median paid workers are lower than the average for comparable organisations
  14. Remuneration committee diversity is monitored and promoted
  15. Used as exemplar by other businesses
  16. Business has clear process of dealing with shareholder opposition to pay, with clear escalation process
  17. Company is actively engaged in improving best practice across the sector, campaigns for better regulation, or similar
  18. Regular review of policies and procedures, and comparison of pay within sector
  19. Business is able to justify levels of pay in relation to comparable organisations
  20. Business is able to justify pay ratios between highest and lowest paid, and highest and median worker in relation to comparable organisations
To receive a score of 'Good'

The business demonstrates a commitment and has clear practices in place regarding responsible executive pay

Examples of policy and practice which may support the GOOD statement:

  1. Company has policies in place regarding executive pay and consistently implements them
  2. Company complies with regulation and best practice regarding executive pay
  3. Levels of executive pay are lower than the average for comparable organisations
  4. Internal pay ratios between executives are lower than the average for comparable organisations
  5. Policies on pay for executives and staff are publicly available
  6. Pay policies include contractors, freelancers etc
  7. Company discloses contents of executive pay, including bonuses, share options etc,
  8. States what performance related pay is based on
  9. Transparent on staff progression and pay
  10. Basic pay levels set in consultation with and collaboration with employees, employee representatives or experts
  11. Regular review of policies and procedures, and comparison of pay within sector
  12. Pay ratios are published between executives and other members of staff
  13. Company is engaged in efforts to improve practices and policies across sector, country etc, but takes a supporting rather than leading role
To receive a score of 'Okay'

Business supports efforts regarding responsible executive pay on an ad hoc basis OR this issue is not material or relevant to the business

Examples of policy and practice which may support the OKAY statement:

  1. Publishes single figure of executive pay, including structure of pay package
  2. Levels of executive pay are close to the average for comparable organisations
  3. Internal pay ratios are close to the average for comparable organisations
  4. Some policies in place regarding how executive pay is decided
  5. Some transparency regarding the decision-making process
  6. Statement of future intent to improve
  7. Reporting on the issue is ad hoc, inconsistent or fails to measure all aspects of the issue
  8. Has a policy regarding pay in place, but the policy fails to address all issues, or is inconsistently implemented
  9. Statement of ‘no employees,’ appropriate to business
To receive a score of 'Poor'

The business acknowledges performance below expectations or no reasonable explanation for high executive pay is offered

Examples of policy and practice which may support the POOR statement:

  1. Little or no action apparent
  2. Policies are in place, but they are ineffective or counterproductive
  3. Levels of executive pay are significantly higher than the average for comparable organisations
  4. Levels of executive pay or internal pay ratios are not monitored by the organisation
  5. Pay ratios between executives and low and median paid workers are significantly higher than the average for comparable organisations
  6. Business persists with high executive pay reward despite shareholder opposition
  7. Internal pay ratio is large but without justification
  8. The company actively campaigns against attempts, either through regulation or public pressure, to implement responsible pay policies or strategies that would aid its implementation