Thursday 8 September 2011

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By Deborah Hargreaves, Chair of the High Pay Commission

By 2030, Britain will be back to levels of inequality last seen in the Victorian era if pay trends go unchallenged. The High Pay Commission’s recent interim report found that the top 0.1 per cent of earners will take home 10 per cent of national income by 2025 and 14 per cent by 2030 on the present trajectory.

The public is angry about the yawning gap that has opened up between rich and poor. In an ICM poll for the commission, 72 per cent of those questioned felt that high pay made Britain grossly unequal. Concerns are legitimate. FTSE 100 bosses are paid 145 times the average wage and, on current trends, this would rise to 214 times by 2020. Corporate leaders have seen their pay quadruple in the past 10 years, while average earnings increased at just 0.1 per cent a year.

Meanwhile, share prices dropped. This decoupling between pay and company performance is of great concern. In the poll, 73 per cent said they had no faith in business or government to tackle excessive pay.

There are strong moral arguments to make against inequality, not least that it creates an elite with access to a range of high-end private services and little concept of the difficulties faced by the public during economic austerity. But there is also a strong economic argument against devoting the lion’s share of rewards to those at the top: it is a very inefficient allocation of resources. Wealthy people tend to save more of their income, which means there is little trickle-down to the rest of society. If the spoils were divided more equally, those in the “squeezed middle” would spend more and help get the economy back on its feet.

Several factors have contributed to the arms race in pay at the top. Perhaps surprisingly, some corporate governance reforms introduced to improve executive accountability to shareholders appear to have pushed pay up. For example, publication of data on executive packages has seen the growth of an industry devoted to comparing pay levels. This means executives can demand they earn as much as rivals and remuneration committees aim to be in the top quartile for pay. That is not to say we should have less disclosure, only that it could be done better.

At the same time, attempts to link executive pay to company performance by increasing the discretionary portion of business leaders’ packages appear to have led to ever-rising awards. In return for accepting performance-linked packages, executives seem to have demanded compensating increases in base salary.
Performance elements of the package have also increased sharply. Last year, the average top award that could be achieved under all share-based incentive schemes in the FTSE 100 was 328 per cent of salary compared with 174 per cent in 2006.

At the High Pay Commission we suspect that performance-linked incentives are a lot weaker than claimed, with many designed to pay out in too broad a range of circumstances. We are conducting our own research this summer into the issue.
[Latest publication 6th Sep 2011: "What are we paying for: Exploring executive pay and performance"]

We believe that reforms to challenge the inexorable rise of top pay are overdue and this is echoed by a growing public backlash. In fact, our interviews with top earners have often thrown up suggestions that the system is unsustainable and should be tackled. But insiders appear reluctant to break rank.

A range of options could be brought forward. Reform of remuneration committees is a compelling idea that is gaining momentum. Elections to the remuneration committee, and particularly the inclusion of employee representatives, could shine some light on the process and put a brake on awards.

We back the publication of pay ratios – top bosses to median pay – as advocated by Will Hutton’s review of public sector pay. If disclosed in a uniform way, these could inform the debate. However, the imposition of a statutory ratio on companies could have adverse consequences such as the outsourcing of low-paid jobs.

More important for shareholders is the simplification of executive packages. These have become so complex that they are difficult to understand, require a lot of investors’ time and remain opaque. What is wrong with a base salary along with some share incentive? If shares were held until retirement or resignation, that would provide a long-term focus for the executive.

These are all areas we will be looking at in detail over the coming months; any proposals will need to be tested carefully. But we are concerned that the laissez-faire approach of the past 10 years has become unsustainable and believe action is required.
Deborah Hargreaves is chair of the High Pay Commission

This article first appeared in Financial World, the monthly magazine of ifs School of Finance, which is produced by the CSFI think-tank.


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