One lucky person won just over £18m in the National Lottery draw over the weekend. But some are winning the lottery every year in the boardrooms of Britain’s biggest companies. The CEOs of FTSE 100 companies earn on average 120 times the median total salary of full-time employees in the UK, taking home £3.45m, compared with £28,758.
At the extreme end of the spectrum is Persimmon, the famous UK housebuilder. It came to light at the end of last year that more than £500m is to be dished out to its senior team under an executive remuneration scheme, including an award of more than £100m to the chief executive, Jack Fairburn – more than five times the winnings of Saturday’s lucky Lotto winner.
But surely company leaders are simply paid the going rate, in recognition of the disproportionate added value they bring to a firm through their skill and genius? In the first decade of this century, FTSE 350 firms increased their pre-tax profits by 50 per cent and their earnings per share by 73 per cent. However, over the same period bonuses for executives in these companies rose by 187 per cent and long-term incentive awards increased by a staggering 254 per cent. Lancaster University Business School, which has done a huge amount of research in this area, has found that the relationship between executive pay and corporate value creation in this country is “negligible at best”. So this excess is very hard to justify.
At Persimmon, the pay of its leadership team was roundly condemned because the remuneration scheme was linked to the share price that had since increased, leading to vastly outsized bonuses that were not subject to any cap. The share price of the company – like many housebuilders – received a giant boost from George Osborne’s Help to Buy scheme when he was Chancellor. In this sense the scheme was a bit of a lottery for the senior team, indirectly subsidised by the taxpayer, and they hit the jackpot – no wonder there was public outrage. The chairman of Persimmon, Nicholas Wrigley, resigned in the wake of the uproar, admitting that they had omitted to insert a cap into the company’s bonus scheme like other firms.
There are more than five million businesses in this country, with the overwhelming majority being small and medium-sized firms whose leaders don’t take home anything like these sums, with many sometimes paying themselves less than they pay their employees. But every time big stories like these hit the headlines involving the big names, business in general often ends up unfairly being tarred with the same brush and it corrodes trust. That is why it is important for business to lead the charge on reform and not stand back from it assuming a defensive position. The Institute of Directors is already an active player in this debate, but more must follow.
Whether big business leaders like it or not, their pay packages have become a symbol for what is wrong with our economic and political system. The ratio between CEO pay and the average wages of employees was 75:1 in 2012. Now it is 120:1, and inequality is set to increase at its fastest rate since 1980. It is simply not credible or right to try to defend the status quo because the accelerating pay ratio tells a story about what people think our country is becoming: a tiny elite consuming far too much of everything; an economy extracting wealth rather than making it; a society in which the powerful put their rights before their obligations; whilst millions are abandoned to dead-end jobs and low wages, feeling they have no stake in the future of the country.
Exorbitant boardroom pay is actually bad for business itself too. It can drive the wrong behaviours with leadership teams looking for quick returns instead of decision-making in the long-term interests of their company. And you do have to ask: if a firm is so concerned that a CEO won’t be motivated to work hard without an exorbitant bonus, maybe it has the wrong person in the job? It is certainly not a great motivator of the principal drivers of profitability in a business – the wider workforce. A survey by the Chartered Institute of Personnel and Development found that 60 per cent of workers thought CEO pay levels actually demotivated employees in a business. There is also the issue of to what better use the millions going into the pockets of CEOs could be put, such as investment in skills, plant and machinery, research and development, and so on.
Boardroom excess is undoubtedly not a good thing for our economy. Outlandish executive pay in some sectors has drained talent from other sectors and distorted the market. Entrepreneurs are the lifeblood of our economy, providing approximately two-thirds of private sector jobs and almost half of private sector turnover. We need people to take risks and set up these businesses (very few FTSE100 leaders founded their businesses). However, why would these entrepreneurs do so if they are going to earn excessive wealth in the boardroom or in the City?
And this of course all drives inequality which is bad for society. The IMF published a paper back in 2014 that supports the analysis of the Nobel Prize-winning economist Joseph Stiglitz that greater inequality leads to shorter and more volatile spells of economic growth and more frequent and severe boom-and-bust cycles. We know what profound inequality brings. It inhibits social mobility. In highly unequal societies, health and social problems including mental illness, drug addiction, obesity and imprisonment are up to 10 times as common and can provoke feelings of superiority and inferiority, dominance and subordination, as people equate outward wealth with inner worth, as Richard Wilkinson and Kate Pickett set out in their seminal book The Spirit Level.
So what changes need to be made? The debate has become polarised between those who believe the market, not the state, should set the rate at which people are paid; and others who believe a simple arbitrary cap by reference to a pay ratio should be set to determine what people receive. Neither will work or is desirable. I happen to believe that the better course is to build a regulatory framework that links pay to the contribution made and what can be considered just and proportional in each individual case.
I have set out some suggestions in my pamphlet – “Reciprocity at the top table: Progress on boardroom pay” – published last week by the High Pay Centre. Implementing all the recommendations of the 2012 High Pay Commission is a good place to start including by putting an employee representative on the Board remuneration committee – if you can’t justify the CEO’s pay package to an ordinary employee, there is probably something wrong with it.
Theresa May ran for the Tory leadership promising to do this, but promptly dropped the idea when she became Prime Minister. Put in place a new regulatory framework to incentivise companies to adopt pay structures for senior executives based on long-term equity and debt holdings for at least five years, and we avoid the perversity of the long-term incentive plan of the Persimmon variety. And give shareholders a more active role in the appointment of board directors and the setting of their remuneration, as they do in Sweden. But, above all, promote a system that gives employees – not just the senior leadership team – a far greater direct stake in the company. Deep in our national culture is the notion of reciprocity – if you work hard and play by the rules, you will see a return and that must mean greater employee-ownership in Britain.
Initially, when challenged over his bonus, the response of Persimmon’s CEO was to state his pay was a “private matter” and to claim that the senior leadership team had “worked very hard” in defence of what they had received. Last week, announcing he would be giving an undisclosed sum to charity to benefit wider society, Fairburn relented and said: “I would like to make it clear that I did not seek these levels of award nor do I consider it right to keep them entirely for myself.”
He was right to relent, but it would be far better to have a better functioning system without the need for ad hoc charitable donations in the event that your pay packet causes a national outcry.
In the end, however much some in business will claim all the credit for their firm’s performance and profitability, business and society are mutually dependent. We need business to provide the jobs, prosperity, international competitiveness and more; but they need society to provide the talent, workforce, publicly funded infrastructure and our custom. Business cannot stand aside from society – they are active citizens of it. We stand and we fall together. That is why this matters and is a legitimate issue of public interest.