Executive Pay: What Executives Think

High executive Pay

There was an article published a couple of weeks ago that I found almost by accident. I didn’t read or hear about it anywhere else and it certainly didn’t get any discernible news courage that I saw.

The article headline was “pay for FTSE100 chiefs rises by 12% despite cost of living crisis”. It was from data published by Deloitte from the first 55 companies to publish their 2022 annual reports from last year.

It’s predicted that 2023 will be a more challenging year for executive pay as there’ll be more scrutiny following a bumper year last year as investors supported increases following more restraint during the pandemic. Investors meetings, where votes will take place on executive teams’ pay and governance by shareholder, are due to take place over the spring and summer.

Just when you might think the table of huge remuneration packages for executives might be on the out, long comes AIG with a proposal for a $50m award for its CEO. Investors have been urged to oppose the proposal saying it was ‘excessive and insufficiently tied to performance”.

This is against a backdrop of London Business School reporting that 77 per cent of institutional investors in UK equities believe that chief executives’ pay is too high, and more than 80 per cent blame “ineffective” boards for not lowering it.

The Chartered Institute of Personnel and Development concur. In one of their Viewpoint research summaries – which are excellent by the way – they are prepared to take a stand on the issue. They believe that, and I quote “The gap between the highest and lowest earners in society is a factor in undermining trust in business and raising concerns over poor corporate governance.”

The consequence of this is that the top 1 percent’s share of total income has reached 19 percent in the US, 13 percent in the UK and Germany and 10 percent in France.

In terms of how this relates as a ratio of median CEO total earnings to all employee average earnings, between 1965-2020 on the FTSE100 the ratio was 22:1 and on the Fortune 350 is was similar at 21:1. Meaning the average CEO salary was 22 times that of the average salary. The ratio peaked in the US in 2000 when it gone up from 21:1 to 366:1 and as of 2020 was a 320:1.

In the UK the ratio peaked in 2015 at 163:1 and it seemed to have been stabilising at around 135:1 before the pandemic – when it fell sharply to. But what that still meant in real money in 2020 was an average CEO salary of £2.7m (down from £3.25 before the pandemic) compared to the UK national average salary of just over £28,000.

We’ll all have opinions about this depending on our philosophical and political leanings. But what I’d like to focus on in today’s podcast is whether high executive pay is ethical and what executives themselves make of it.

Because, what struck me about this is that when I speak with CEOs and other executive directors, they agree that excessive pay and reward packages are obscene.

The newly recruited CEO of Deutshe Bank said: “I have no idea why I was offered a contract with a bonus in it because I promise you I will not work any harder or any less hard in any year, in any day because someone is going to pay me more or less”.

Indeed, one of the criticisms of outlandishly high executive pay is that it’s unnecessary because people tend to work of intrinsic rather than extrinsic rewards.

That’s all anecdotal. But what about research – is there any out there that has any empirical weight behind it of what the executives themselves think of the way pay is being awarded for C-suite level professionals?

The answer is yes. And it’s really interesting.

What do CEOs think about it?

My curiosity took me to a little known but excellent book by an academic at the London School of Economics called “If you’re so ethical, why are you so highly paid?” I’ll link to it in the show notes.

In the book the author, Alexander Pepper, aimed to answer the question: Are executives taking amounts exceeding that which is economically or socially necessary?

What was the most fascinating about the issue of executive pay from Pepper’s research is that executive leaders themselves find it overdone. They are caught in a system that is wickedly hard to break.

The design of the research is itself very interesting. Pepper started life as a philosopher before becoming an accountant with a specialist interest in exec remuneration at PwC.

We know that in the social sciences, research knowledge is created through empirical studies – the collection of data to determine the ‘facts’. But philosophers work with thought experiments – hypothetical scenarios that paint the detail of an idea.

Alexander Pepper does a very elegant thing in his book by combing both.

He asked CEOs to consider a hypothetical scenario as it relates to executive pay and renumeration. The scenario is based on the work of the moral philosopher John Rawls, who’s considered to be one of the most influential moral philosophers of our time.

At the heart of Rawl’s ideas is that society should be fair. And that we determine if something is fair if we consider a situation from what he calls the original position – a position where we make our decisions behind a veil of ignorance; that we don’t know what our role is in a society when we make decisions about what is fair in it. So, in the case of executive pay, in coming to an ethical decision about what is fair and just, you don’t know if you are making the decision as a CEO who is the likely recipient of the large remuneration package, or someone who is in an entry level position.

He asked the question: What principles governing the distribution of income would you want to apply in the society in which you lived if you did not know your place in that society?”

The CEO respondents were offered a series of six principles of distributive justice such as: Some people deserve to receive certain economic advantages in light of their contribution, effort, experience, and the demands of the job.

And another one states: Income should be distributed so as to make the worst-off members of society as well-off as possible. All of the statements related to a standard political or philosophical position.

Pepper noted that the executives who responded took the idea of distributive justice “very seriously” noting that they agreed or strongly agreed with more principles of justice than they disavowed. And, their narrative comments were consistent with “a serious ethical perspective on pay and inequality”.

So if executives largely want fairness and justice in pay and reward, if general society wants in and the investory community, as I’ve already outlined, also want it: why isn’t it changing?

Pepper believes that it’s not about the greed of CEOs as the media might have us believe, but rather that RemCos, CEOs and investors are locked into a poorly designed system that’s evolved over the last few decades.

A broken system

The main argument for high levels of CEO and executive pay is that it’s linked to performance. But evidence gathered over the past 35 years has failed to establish a statistically significant link between executive pay and a firm’s financial performance. Most economists now appear to accept that the strongest correlation is between pay and firm size, not between pay and financial performance.

And again, the CIPD agrees saying that firms find it challenging to connect their business strategy to their remuneration strategy, or to demonstrate a clear link between CEO pay and an organisation’s overall performance.

Government has been reluctant to get involved and has instead left it to the market.

And this has played out in what’s been referred to as the Remuneration Committee’s Dilemma. That is that RemCos are caught in an amplifying mechanism where they’re faced with the quandary that in an open market there is much more to lose in paying less and getting a bad CEO than paying more against criticism of CEO pay inflation. (Even though this is a presumption that not always tested). So they end up chronically paying over the odds.

The adoption of LTIPs (Long Term Incentive Plans) which are vested over a long period of time have also been blamed for skyrocketing executive remuneration.

But perhaps the tide is turning.

There’s been a move away from LTIP, notably following on from Weir Group plc who replaced the LTIP in 2018 with a restricted share plan. Since then a number of UK companies such as BT Group and Lloyds Bank for since adopted similar plans.

ESG investing is also having an impact. Large institutional investors are increasingly encouraging moderation as well as simplification in pay practices and since they have begun to do this, the pay curve of executives has begun to decline.

It’s too early to tell if the tide is turning on executive pay, but it looks like everyone wants a more balanced and moderate approach, which will be good for the trust in business and in leaders in the long run.

References

You can download Alexander Pepper’s book, “If you’re so ethical, why are you so highly paid?” free, directly from the LSE here: https://press.lse.ac.uk/site/books/m/10.31389/lsepress/eth/