Justifying the executive pay gap

Justifying the executive pay gap

Twenty years ago, the average level of executive pay was around forty times that of the average worker. Today the comparison figure stands at over 120, meaning that by 4th January 2018 FTSE 100 executives on average had already earned what their employees would expect to earn throughout the entire year.

Given the escalating pay gap it is hardly surprising therefore that in 2017 the UK government took the decision to consult on a number of pay differential measures. Now, on 11 June 2018, the government has placed legislation before Parliament which, in the words of the government press release, “will hold big businesses to account for the salaries they pay, while giving employees a greater voice in the boardroom.”

The headline measure from the proposed legislation is the requirement for all listed companies with more than 250 employees to not only reveal the pay gap between executives and employees, but also to justify that difference. In addition, directors will have to set out how any change in share price would affect their own remuneration.

For those who are less concerned with director remuneration and more in how the executive team is performing, the new regulations also call for directors to ‘set out how they are acting in the interests of employees and shareholders.’ Unlisted organisations also come in for some scrutiny with a proposal for large private companies to report on their responsible business arrangements.

Whilst the proposals stop short of introducing a cap on executive pay, it is clear that these measures are intended to promote shareholder and investor confidence. And it is fair to say that the draft legislation has received widespread approval. Commenting on the proposals the CBI’s chief UK policy director, Matthew Fell, said “The CBI is clear that high pay is only ever justified by outstanding performance. High pay for mediocre or poor performance is unacceptable.”

Echoing these comments the Chief Executive of the Investment Association, Cris Cummings said “we welcome today’s package of reforms as they focus on the long-term interest of all company stakeholders, including shareholders and employees.” He also added that investors would expect boards to articulate why the pay ratio “is right for the company and how directors are fulfilling their duties.”

The openness and accountability required by these proposals in many ways reflects the current corporate governance approach which looks to move boardrooms and boardroom decisions away from a closed environment and towards a more open dialogue with stakeholders. It is currently anticipated that the legislation would pass into force on 1st January 2019 which means that companies would start to report their pay ratios in 2020.

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