‘We need to rethink conventional wisdom about pay’
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When Labour’s John McDonnell called for greater worker representation late last year as a way to curb top executive pay, the UK’s shadow chancellor appeared to hit a nerve.
A report co-commissioned by Mr McDonnell included proposals to ban all share options and allow customers of the 7,000 biggest companies in the UK to vote on executive pay. Business bodies stepped forward to explain why it was a bad idea.
Chief executives’ mean pay was 145 times the mean wage of the average worker in FTSE 100 companies in 2017, according to research by the High Pay Centre. Politicians have called for more worker involvement in the upper levels of management to help limit excessive salaries.
Deborah Hargreaves, founding director and former chief executive of the Centre, says it has long advocated having an employee representative on the board and remuneration committee. Similar policies are being considered by both President Emmanuel Macron in France, and US presidential hopeful Elizabeth Warren. However, Ms Hargreaves says: “It has always been strongly resisted by business, who don’t want to have to engage with the workforce on this issue.”
Others argue that senior executives’ high pay is not the problem: it is usually small by comparison with profits and paying executives competitively ensures the business can attract the best candidates.
Professor Kevin Murphy of USC Marshall School of Business in California warns against government intervention on executive pay. He says it is not a cause of growing income inequality, adding: “Every time the government has tried to fix it, it makes it worse.”
However, executive pay sends a strong message about a company’s priorities.
When it comes to building a long-term business, “the measure we are using [the pay ratio] is not appropriate for the problem we want to solve,” says Ethan Rouen, assistant professor at Harvard Business School: “We need to rethink conventional wisdom about pay.”
One remedy might be to make sure pay is more balanced throughout the organisation. “When you pay lower-level employees more, when you increase the fairness, you increase productivity and the costs are outweighed by productivity gains,” says Prof Rouen.
Employee representation at senior management level is regularly proffered as a way to make employees feel empowered, improve operations and encourage long-term thinking.
“There is perennial concern about short-termism in public companies,” Prof Rouen says. “Employees, on the other hand, are less concerned with the [financial] quarter and more concerned with ensuring that a sustainable business is created and protected.”
Employees sitting on boards or advisory committees is still relatively untested, and the effects on corporate health are unclear. In 2011 the research arm of the EU confederation of trade unions published a review of the 17 EU member states (and Norway) that have legal provisions for employee representation in companies. It found that the measure had no clear effect on company economic performance, although in some instances profitability went down because wages increased.
German companies’ two-tier structure, with a management and a supervisory board, is often held up as an example by advocates of employee involvement at board level. Yet critics point to its potential to foster poor governance, citing the “Volkswagen system”, where a powerful employee voice at the German carmaker may have contributed to a dysfunctional culture, reduced profits, and scandal.
Moreover, Germany has one of the highest chief executive pay rates in Europe, with total remuneration of executives of listed companies comparable to the UK and 38 per cent higher than France, according to research by Belgium’s Vlerick Business School. “When employees are represented on the board, exec pay tends to be higher,” says Xavier Baeten, a professor at Vlerick. “One explanation is that their perspectives change once they are on the board.”
Rather than simply reducing senior executive pay, the best practice in corporate governance is to structure it in a way that discourages short-term planning and thinking, say advocates.
Executive pay typically comprises a cash salary, stock options and performance-related bonuses.
Alex Edmans, professor of finance at London Business School, says their relative balance affects chief executives’ decisions. He argues that pay should encourage long-term thinking by company leaders, for instance by tying their remuneration to long-term share price — including after they leave the organisation.
Prof Edmans points to Paul Polman, outgoing chief executive of Unilever, under whose leadership the global consumer goods company was respected for both good governance and its emphasis on long-term performance. Part of Mr Polman’s reward must remain tied up in company shares for two years after his departure.
“This also encourages the chief executive to engage in one of the most important decisions, which is succession planning,” says Prof Edmans.
Still, growing pay inequality remains a hot political question. Ms Hargreaves says executive pay and perceived unfairness have effects beyond the boardroom: “This whole populism shift and Brexit vote is tied in with these huge pay differentials. The vast majority of people feel they don’t have a stake in the economy.”
“It would be a positive step to give workers a meaningful voice,” says Robert Reich, former US Secretary of Labor in the Ford, Carter and Clinton administrations. “But that’s just a piece of the puzzle.”
The economy has grown, he says, but the benefits have been limited to company owners, top executives and shareholders, while workers’ wages remained stagnant. “The richest 1 per cent of Americans own about 40 per cent of all shares, and the richest 10 per cent own 80 per cent. Shareholder capitalism leaves out the vast majority of Americans.”
He adds: “We have to rethink corporate capitalism in a profound way because it’s just not working for most people.”
Additional reporting by James Robertson