Chief Execs should think mission before money

Theresa May’s proposal to publish the pay ratios between executives and shop floor workers has prompted a predictable backlash from business elites. She must persevere. The stratospheric rise in executive pay is socially damaging and contributes little to economic performance.

The RSA recently became accredited as a Living Wage Employer but there is an equally important pay metric that the RSA also meets comfortably. This is the ratio between the highest and lowest paid employees. There is currently no certificate for this, but might this change with the Government including provisions to publish pay ratios in the green paper on corporate governance?

What is the pay ratio?

Put simply, how much more does an executive earn compared with the average worker? There are a number of different ways to calculate this, which I will come back to.

At the RSA the role of chief executive carries a salary of £120,000 which means he receives 3.4 times the median RSA employee and 7 times the earnings of our interns (who are paid the London living wage).

By contrast, the High Pay Centre calculates that average FTSE-100 chief executive pay of £5.5m was 129 times that of their workers in 2015. Among the same group of companies only a quarter are accredited Living Wage Employers. A survey of 168 large companies in the US found a ratio of 70:1 – perhaps surprisingly well below the top 100 UK-based companies.

The largest ratio in the US survey was 434:1 but the top spot in recent times must surely go to Bob Diamond. When CEO of Barclays he managed to exceed a pay ratio of 1000 times his lowest paid workers.

These are figures so extreme that they would probably cause even the robber barons of yesteryear to blush. J P Morgan, captain of American industry and founder of the investment bank that bears his name, once opined that no one at the top of a company should earn more than 20 times those at the bottom.

Indeed the gap between workers and bosses was in line with this as recently as 1965 in the US. Since then executive pay has grown by around 1000% while US median wages has inched up by just over 10%.

Why does this matter?

In short, because runaway remuneration for the richest in society is a social blight. In their landmark 2009 book ‘The Spirit Level’, Richard Wilkinson and Kate Pickett made a compelling case that excessive inequality within rich countries is associated with a plethora of problems across social indicators: physical health, mental health, drug abuse, educational attainment, imprisonment, obesity, social mobility, trust and community life, violence, teenage pregnancies, and child well-being.

For all these indicators, outcomes are significantly worse in more unequal rich countries.

There is now a feature documentary based on the book called ‘The Divide’. It does not preach or condemn. It does not campaign or call for action and nor does it provide a shopping list of policy demands.

What it does do is simply tell the story of seven ordinary people in the USA and UK to explore what the book’s scatter graphs and regression analyses feel like in real life.

This is no anti-capitalist street protest.

For me, two standout contributions from the various talking head experts in the documentary are from Sir Alan Budd and Sir Max Hastings.

Budd, one of the architects of Thatcherism, expresses his regret at the extreme inequality that has emerged since the early 1980’s. For him, this was never the intention of implementing free market reforms. Hastings is even more explicit, arguing that the excessive pay in the financial sector is a sign of capitalism malfunctioning, not a necessary part of it.

Indeed any free market purist would, in my view, condemn the relentless rise in executive salaries over recent years as rent-seeking behaviour enabled by a failure of competitive markets. This has very little to do with wealth creation, and everything to do with exploiting power.

But will dampening executive pay damage the economy?

Did the explosion of executive pay and economic inequality since the 1980’s bring us to a new economic nirvana?

Although for individual companies there are examples of high pay for high performance, there are just as many examples of the opposite. For the executive class and their hangers-on in the executive search and selection industry, it’s heads I win, tails you lose.

At the whole economy level it would be impossible to reliably untangle all the different factors in macroeconomic performance but as we survey the post-Brexit rubble of Thatcher-Blair-Cameron-ism, with its narrative of the ‘left-behinds’ and the catastrophic failure of free-market fundamentalism in leading us to the global financial crisis and most severe recession in the post-war era, I find myself in the ‘time to try something different’ camp.

So, should we do it?

There are some potential pitfalls in forcing disclosure of the pay ratio. These essentially boil down to deciding how you calculate it and the danger of perverse unintended consequences.

There is of course the objection once put to me by an executive search consultant that this is merely the “politics of envy”. Maybe it is, but that’s just what comes after 40 years of the economics of greed.

To the more serious objections, I would argue that the calculation issue is not hard to deal with. Should we relate earnings at the top to earnings in the middle (median earnings) or those at the bottom? Easy, publish both.

But what about the difficulty of comparing between industries and business models – known as the Goldman-John Lewis anomaly? If a company, such as Goldman Sachs, has a smaller number of very highly paid workers because it is in a high pay industry (investment banking) it will appear less unequal than a company such as John Lewis in a low-pay industry (retail).

First, the calculation should include contractors, so Goldman’s security guards and cleaners would come into the equation.

Second, we should also include the ratio of company executives to the UK-wide median wage. After all, as George Osborne once said, we are all in this together.

In practice, people will compare retailers with other retailers, and banks with other banks, so this objection can be safely downplayed.

But what about the danger that British companies will find it difficult to attract the top talent necessary for our businesses to succeed?

Much has been made of a recent report from a business group called the Big Innovation Centre which argued against publishing the pay ratio. They do express concern about the potential perverse effects of publishing the ratio.

But in the report they also argue for much higher levels of transparency in disclosure of executive pay, and how it relates (or not) to both company performance over time and wages in general. They also recommend stronger powers for stakeholders and shareholders in scrutinising and controlling executive pay.

In many ways the report runs with the grain of Theresa May’s proposals, not against it.

Some of the objections they raise I have dealt with above. But here are two final arguments in favour of the UK biting the bullet and implementing the disclosure of executive pay ratios.

1. They are doing it in the US

In the USA a new rule is about to kick in as part of the Dodd-Frank post-financial crisis reforms that requires public companies to disclose the ratio. This severely undermines the claim that the UK will no longer be able to compete in the global marketplace for executives. Instead, it is more the case that it is actually the UK that is undermining global efforts to restrain excessive executive pay

2. If a CEO is so focused on the money, do you even want to appoint him?

What motivates your leader, the money or the mission? In an era when all the talk about ingredients for corporate success focus on defining purpose, where a company’s broader performance on social, environmental and governance factors is becoming ever more important to investors, customers and employees, and where the pursuit of long-term mission is more important the pursuit of short-term profit, where do you want your chief executive’s heart to lie?

When the Harvard Business Review changed the way it ranks the performance of executives to include their social and environmental performance, little known CEO Lars Sorensen of Danish pharmaceutical firm, Novo Nordisk, shot to the top of the league table of best-performing CEOs in the world.

His views on executive pay are worthy of repeating:

“I saw that in last year's list of best-performing CEOs, I was one of the lowest paid. My pay is a reflection of our company's desire to have internal cohesion. When we make decisions, the employees should be part of the journey and should know they're not just filling my pockets.” (Novo Nordisk CEO named world's best)

So my humble suggestion to the boards and shareholders of our largest companies is that if your candidate for CEO baulks at disclosing the ratio between his pay and that of ordinary workers, he is probably the wrong person for the job.