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Risk and reward

Executive pay

The chasm between the pay of ordinary workers and those at the top has led to initiatives such as ‘say on pay’, but are they enough to narrow the gap?

The princely pay of top business leaders has long been grudgingly tolerated in the UK and US. From time to time a particularly lavish pay award generated a few days of hostile headlines before the furore died down. Recently, however, this tacit acceptance of jumbo pay for chief executives has been wearing thin.

The rich rewards for those at the top, often endured by the public during more prosperous times, have rankled ever more as the wages of ordinary citizens have stagnated. This frustration has helped fuel anti-capitalist protests around the world and focused attention on growing inequality. Politicians on both sides of the Atlantic have responded by introducing measures aimed at slowing the relentless rise in top pay. 2012 is likely to be a crucial year in the drive to narrow the gap between the highest and lowest paid.

One might have expected sluggish economic growth in most rich nations to take the steam out of executive pay. It has not. While top pay dipped immediately after the 2008 financial crisis, it has bounced back smartly in recent years. The sharpest rises were in the US and UK, which have long rewarded corporate bigwigs more richly than rivals in continental Europe. Compensation of chief executives of S&P 500 firms soared by a median of 36.5% in 2010, according to GMI’s CEO Pay Survey 2011. Their British counterparts meanwhile enjoyed a 43% boost to pay, Incomes Data Services calculated. 

And this is far more than just one year of excess. Decades of generous increases have taken top pay to stratospheric heights. In 1976 the average American CEO took home around 36 times as much as the average worker. This had climbed to 131 times by 1993. Now a company’s top dog typically makes over 300 times the firm’s average salary, according to a recent reckoning by the Institute of Policy Studies in Washington. Around 25 US companies actually paid their top executive more than they paid Uncle Sam in federal income taxes. Meanwhile, over the last decade the real income of the average American has actually fallen by around 6%.

The situation in the UK is only marginally better, figures from the UK’s High Pay Commission show. In 2009–11, the chief executive of BP was taking home 63 times more than the average worker, compared with just 16.5 times in 1979–80.

It is hard to argue that these are the just rewards for extraordinary talent. Pay disparities are far more modest in Germany, where chief executives earn on average about 12 times as much as workers, a study by Towers Watson concluded.

This lower pay doesn’t seem to have hurt performance. Indeed, over the past 15 years chief executives in continental Europe have on average turned in superior results than their better paid peers in the UK and US – delivering returns of 136% against 120% for firms in the FTSE 100 and S&P 500. In addition, examples abound of executives who enriched themselves while doing a terrible job for shareholders. John Chambers took home US$393m between 1999 and 2009 for leading Cisco Systems. Yet US$100 invested in the firm in 1999 was worth just US$71 a decade later, The Wall Street Journal calculated.

It is also misleading to argue, as many companies do, that pay is being forced higher by natural market forces since globalisation allows executives to go wherever they will be best rewarded for their talents. The High Pay Commission argues that chief executives are far less mobile than the myth suggests. They found only one example of a successful FTSE 100 chief being poached in the past five years – by a British company. ‘Globalisation is used to justify lower pay for the poor and higher pay for the rich,’ says Deborah Hargreaves, who chairs the commission. ‘But there is no reason why lower chief executive pay outside the US and UK should not actually push down wages. After all, if a French chief can do the job for half the price, why pay so much for a native one?’

So should the public be concerned if shareholders are throwing money away by overpaying chief executives? The answer is probably yes. First, higher pay for a chief executive takes cash away from other employees of a company. This growing inequality can be economically damaging, as US president Barack Obama pointed out in a recent speech. ‘When middle-class families can no longer afford to buy the goods and services that businesses are selling...it drags down the entire economy,’ he said.

Meanwhile, the ultra-rich spend a far higher proportion of their income on assets – including stocks and property – which can exacerbate asset bubbles. Obama pointed to one recent study showing that more equal societies tend to enjoy stronger and steadier economic growth over the longer term.

Vast income gaps can also harm democracy, giving ‘an outsized voice to the few who can afford high-priced lobbyists and unlimited campaign contributions’, as Obama put it. Since this plutocratic elite has no need for social services such as public education or healthcare, they may seek to undermine such institutions in the interest of lowering taxes.

So with top politicians like Obama and UK prime minister David Cameron now on board, can the ratcheting up of executive pay be halted? As of January last year in the US, the owners of a firm have been given the opportunity to cast a non-binding vote against the compensation package being offered to top executives – a so-called ‘say on pay’. However, there are several reasons to doubt it will achieve much. Remarkably few shareholders have been willing to vote against boards on executive pay. Only around 44 boards were faced with a majority vote against their pay awards last year, out of around 3,000 US public companies, according to the GMI. In addition, UK shareholders have had a say on pay for almost a decade and still failed to slow top compensation. ‘Say on pay has not shown great promise,’ says Paul Hodgson, a senior researcher at the GMI.

This article originally appeared in Accountancy Futures issue 5 2012.

Published: 21 Nov 2012