Economic Theory

What’s wrong with disclosing executive pay differentials?


The Equality Trust is the latest organisation to call for the mandatory reporting of the ratio between the pay of the highest and lowest earners in UK companies. At first sight this is a small step that would simply increase transparency in pay practices – who could reasonably object? But in reality this proposal would have no clear benefit and many costs.

For a start, it is worth emphasising that large companies are already required to publish the pay of their highest earners. Bumper packages are therefore exposed to full public scrutiny. Indeed, this is precisely why the Equality Trust was able to arrive at its headline-grabbing estimates of the pay ratios for the FTSE 100. Admittedly, these are estimates only: we do not know the specific numbers for the lower paid in every company. But large differences in the pay ratio from one employer to another are likely to be driven by what’s happening at the top, not at the bottom.

What’s more, additional information is only useful if it is meaningful and can be interpreted consistently and sensibly. Executive pay is rarely a straightforward matter of large amounts of cash paid into a bank account. For example, the Equality Trust focuses on a bumper package received by Martin Sorrell, the CEO of advertising giant WPP. However, the bulk of this package took the form of the one-off release of shares under long-term incentive schemes, whose value will depend on the company continuing to do well. Of course, his annual salary and bonuses are still eye-wateringly high, but they are not so exceptional. There are much better ways to foster the sense that prosperity is being shared, including progressive taxation and clearer penalties for failure to balance rewards for success.

Increased regulation would also have costs. This proposal reflects a mindset in which employers are always the villains, where large financial rewards can never be justified, and where those who are semi-detached from the real world think they know best. None of this is helpful. Similar points apply to the persistent misrepresentation of “gender pay gaps”, which can largely be explained by different choices made between types of employment and career breaks rather than different pay for the same job. The calls for mandatory reporting of pay ratios fit the general narrative of fat cat CEOs gorging themselves on what the Equality Trust automatically assumes to be “obscene and undeserved rewards”. This is also the thinking behind proposals for a legal cap on pay ratios. There are three further problems here.

First, while there are doubtless many CEOs whose massive salaries are not strongly correlated with any objective measures of company performance, there are also many whose salaries are. (Where would WPP be without Sorrell?) Who is to say which are ‘deserving’ and which are not? The best people to decide what a senior executive is worth is surely the company itself and its owners – the shareholders – who ultimately have to pay the bill. After all, one person’s “fat cat boss” may be another’s “entrepreneurial leader”.

Second, the more focus there is on a specific number, the more likely that it will be manipulated. Firms could massage the data by changing the ways in which they pay the people at the top or, worse still, getting rid of those at the bottom. For example, firms could outsource lower paid jobs or dispose of some roles altogether – presumably not the outcome that advocates of this policy would want. Expressing the pay ratio as a multiple of average or median earnings, rather than the lowest, might reduce this particular risk. But this approach would also have even less chance of encouraging firms to raise incomes at the bottom of the scale.

Third, companies could avoid greater scrutiny and interference in their affairs by simply moving away. The FTSE 100 in particular includes many companies that do not have to be headquartered here. If they feel they cannot pay their top people the going rate in the UK, they will shift them abroad – taking their tax revenues and many more jobs with them.

To be clear, some people are undoubtedly paid too much. But the aim should be to raise the incomes of the poorest, rather than to penalise success at the top. This requires grown-up discussions about competitiveness, flexibility and productivity – not name-calling by people who mean well but have little understanding of how the economy or business works.

 

Julian Jessop is an independent economist with over thirty years of experience gained in the public sector, City and consultancy, including senior positions at HM Treasury, HSBC, Standard Chartered Bank and Capital Economics. He was Chief Economist and Head of the Brexit Unit at the IEA until December 2018 and continues to support our work, especially schools outreach, on a pro bono basis.


Leave a Reply

Your email address will not be published.


SIGN UP FOR IEA EMAILS