Reducing the pay gap in UK companies

Today’s report by the High Pay Commission, established by the left-of-centre Compass think tank with the support of the Joseph Rowntree charitable trust, says we need transparency, accountability and fairness to reduce the disparity between average incomes in the UK and those of top executives.

It says the average wage has risen by around 300 per cent since 1980, while the highest paid company executives’ “stratospheric” pay increases have soared by more than 4,000 per cent over the same period.

The report recommends, among other proposals, that companies publish a ratio reflecting the difference between the top and the median wage. It also calls for executive pay to be simplified, and for the establishment of a new body to monitor high pay (the Low Pay Commission already advises the government on implementation of the national minimum wage).

But what are the reasons for the widening pay gap in the UK? Does that gap reflect a trend that is specific to the UK? And are the figures on which the High Pay Commission has based its report justified?

Questions for the commission

Both Barclays and Lloyds have rejected the report’s figures in relation to top executive salaries at the banks.

Lloyds told Channel 4 News: “The High Pay Commission’s figures are flawed. They have compared the average basic salary of our employees to a remuneration package awarded to the CEO that includes salary, bonus and benefits. As a result they have reached an inflated number that is entirely unrepresentative of the truth.”

Barclays, meanwhile, rejected the report’s assertion that its lead executive’s total earnings in 2010 were 4.365m, noting that former chief executive John Varley’s total remuneration as specified in the bank’s 2010 annual report was £3.850m.

Increase in inequality

Nonetheless, the last 30 years has seen a clear divergence between the size of ordinary workers’ and executives’ salaries in large companies. Vincente Cunat, lecturer in finance at the London School of Economics, believes that this reflects a global rather than a UK-specific trend.

“Inequality in the world has been increasing since the 1990s,” he told . “This has to do with many things which are not necessarily associated with poor governance within companies – such as more competition, more competitive labour markets, demand for more skilled workers. All these things push the increase in inequality.”

More competition, more competitive labour markets, demand for more skilled workers, all push the incraese in inequality. Vincente Cunat, LSE

In specific regard to the UK, the disparity has been exaggerated by a more flexible labour market and a wider spread of wage distribution. “So when you reach the top, you’re higher,” Vincente Cunat explains. “Not as high as the United States, but higher than other countries. But this is neither a good nor a bad thing.”

Roger Barker, head of corporate governance at the Institute of Directors, says the technical explanation for greater spread in remuneration in the UK and US is that companies in these countries have a more dispersed shareholder base. “The dispersed shareholder is much less able than the big block holder to control aspects of corporate governance – particularly executive remuneration.”

Individual companies in other countries, by contrast, tend to have big shareholders which can more easily exercise stringent oversight of top pay.

Democratic practice

The High Pay Commission is critical of the complexity of many executive pay packages, which can obscure the extent of an executive’s remuneration.

Roger Barker argues that this complexity stands uneasily alongside the transparency that should form an essential part of business practice in a democratic society. “You have to recognise that most listed companies for many years have been fully transparent in terms of directors’ remuneration, including executive directors.

The High Pay Commission is right to argue in favour of much more simplicity in terms of executive pay. Roger Barker, Institute of Directors

“The lack of transparency derives more from the complexity of many executive pay packets. They’ve grown in complexity in recent years – but often for understandable reasons. There’s been a desire to relate executive pay to company performance, and schemes have been devised to achieve that.

“But the unintended outcome has been a lot of complexity – and probably overall an increase in total executive pay as a result. The High Pay Commission is right to argue in favour of much more simplicity in terms of executive pay.”

Vincente Cunat and Roger Barker agree that the downside of transparency in executive remuneration has been higher salaries. It encourages executives to demand similar levels of pay to those of their rivals in other companies.

The solution, says Vincente Junot, is greater democracy within companies. “Companies in which shareholders have more voice should worry less about executive salaries. We should always be asking: how do we improve the voice of shareholders to make the governance of firms better?”