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Jan 18, 2019

UK regulations force disclosure of top bosses’ pay versus average worker

Critics suggest pay ratios will result in ‘more heat than light’

New UK regulations that came into force at the start of the year mean that for the first time the UK’s biggest companies will have to disclose their top bosses’ pay and the gap between that and the pay of their average worker.

Pay-ratio regulations will apply to large UK listed companies with more than 250 employees, and the first statutory disclosures will need to be provided from the start of 2020, covering CEO and employee pay awarded in 2019.

The pay ratio will mean annual disclosure and comparison of the CEO’s pay with the median, lower quartile and upper quartile pay of its UK employees.

In addition to the reporting of pay ratios, the new laws require all large companies to report on how their directors take employee and other stakeholder interests into account.

The reforms are part of the UK government’s action to upgrade the country’s corporate governance and business environment. Reforms follow support and calls from investors and shareholders for companies to do more to explain how pay in the boardroom aligns with wider company pay and reward.

UK government business secretary Greg Clark says in a statement: ‘Britain has a well-deserved reputation as one of the most dependable and best places in the world to work, invest and do business and the vast majority of our biggest companies act responsibly, with good business practices.

‘We do, however, understand the frustration of workers and shareholders when executive pay is out of step with performance and their concerns are not heard. These new regulations are a key part of the wider package of corporate governance upgrades we are bringing forward as a government to help build a stronger, fairer economy that works for businesses and workers.’

Alongside the pay-ratio reporting, there will be a new statutory duty on companies to set out the impact of share price growth on executive pay outcomes. This aims to provide greater clarity for shareholders about the impact that significant share price growth can have on executive pay outcomes and whether discretion has been exercised before pay awards are finalized.

It is a timely topic: last year a new US financial disclosure rule forced companies to publish the ratio of CEO to worker pay. Research in the US by the Washington-based Economic Policy Institute also reveals the chief executives of America’s top 350 companies earn 312 times more than their workers on average. The research notes that the pay gap has risen dramatically, with some slight fluctuations, since the 1990s. In 1965 the ratio of CEO to worker pay was 20:1; that figure rose to 58:1 by 1989 and peaked in 2000 when CEOs earned 344 times the wage of their average worker.

The remuneration windfall was driven by stock-related components of CEO compensation such as stock awards or the opportunity to cash in stock options, notes Lawrence Mishel, a distinguished fellow at the Economic Policy Institute.

But the rise in such compensation cannot be explained just by rising stock markets. CEO rewards have outstripped both stock prices and corporate profits, EPI finds. Between 1978 and 2017 US CEO compensation increased by 979 percent. Over the same period the S&P 500 Index of the US’ largest companies grew 637 percent. The typical worker’s pay package, meanwhile, rose just 11.2 percent over the same timeframe.

‘Over time I think there has been a loosening of norms,’ says Mishel in a statement. ‘[People] want to believe their CEO is one of the best, so they look around and see what everyone else is being paid and then they pay their CEO a lot more. They think everyone is better than average.’

Assessing the lessons from the US, Mark Reid, global head of Willis Towers Watson’s executive compensation business, tells IR Magazine: ‘The US experience has shown us that CEO pay ratios vary hugely between companies, reflecting different industries, business models and geographic focus much more than they reflect different approaches to pay. As a result, boards, shareholders and even the media have paid less attention to these comparisons between companies than might have been expected.

‘What we have seen is boards focusing on internal communications to employees about the number. While the CEO pay number – the numerator in the ratio – is old news, the median employee pay number – the denominator – is new news and companies are anxious about employees comparing their own pay against this figure or those of their competitors. We expect the same in the UK, with additional focus on long-term trends over time, even though performance variation will cause a lot of noise in the trend.’

Reid is ultimately skeptical of the new rulings. ‘Our view is that while the publication of the CEO ratio will produce more heat than light, it is helpful for boards to think about how the level and structure of executive pay compares with the rest of the organization, ideally in a more nuanced way than a single flawed number,’ he says.