high pay commission final report

8/3/2019 High Pay Commission Final Report

1/38

THE

HIGHPAY

COMMIS

SION


2/38


3/38

The High Pa Commission Cheques With Balances: why tackling high pay

4

7

8

16

22

38

69

70

Foreword b Deborah Hargreae

Executie ummar

1| Introduction

2 | Is the ood to the top a problem?

2.1 The business case for fair pa

2.2 The economic case for fair pa

2.3 The social case for fair pa

3 | Where now?3.1Transparenc

3.2 Accountabilit

3.3 Fairness

4 | Concluion

Annexe

1 The expert panel

2 People the Commission met

3 Information on data

Contents


4/38


6

As Britain enters times of unparalleledausterit, one tin section of societ hasbeen insulated from the downturn. Thatis the top 0.1% of earners, with compandirectors in particular continuing to enjoa huge annual uplift in rewards.

The High Pa Commission has spent thepast ear exploring this growing divisionbetween those at the ver top and everoneelse. Our investigation has led us toconclude that excessive top pa is deepldamaging to the UK as a whole, and actionis urgentl required to address it.

Our work has shown that we mustnow break open the closed shop thatsets pa for our top directors and getback to basics for executive pa. It isclear that we must open up top pa tomore scrutin from a cross-section ofsociet. To do this, our report sets out a12-point plan based on the principles ofaccountabilit, transparenc and fairness.

The public is rapidl running out ofpatience with a sstem that allows thoseat the top to enrich themselves whileeverone else struggles to make endsmeet. This has been thrown into starkrelief b the economic crisis, but hasbeen building for the past 30 ears.

In 1980 top bosses were well rewarded,but the had not pulled so far awa fromthe rest of societ. Since then some ofthem have enjoed an increase of over

Foreword4000% to what are now multi-millionpound packages.

Those in respectable middle class jobssuch as secondar school teachers andpolicemen have seen their income riseb a much more modest amount withaverage wages increasing from 6,474 tojust 25,900 over the same period.

There have been huge changes in all ofthese jobs, et so much wealth has beenchannelled to those at the ver top. Thisis a trend that has led to such a huge risein inequalit over the period that Britain

now has a gap between rich and poor thatrivals that in some developing nations.

The High Pa Commission has soughtto understand these social trends andexplore wh the matter. Fairness is aconcept close to the heart of the Britishpeople and it is essential that we nowredress the balance.

All three political parties have recognisedthe need to tackle top pa. Ministers andpoliticians have spouted much rhetoricabout fairness. We are calling on them totake this agenda forward.

We must now halt the trend towardsgreater inequalit before we end upback at the levels of disparit evident inVictorian England.

DEBORAH HARGREAVES,CHAIR OF THE HIGH PAy COMMISSION

Acknowledgements

The High Pa Commission would like to

thank Steve Tatton and Adam Elstronat Incomes Data Services for their workon the project. We would also like tothank Daniel Harris, Melissa Milner,Jim Minton and the rest of the team atDHA Communications. A further thanksis given to Howard Reed of LandmanEconomics and Nick Isles of CorporateAgenda for all their support.


5/38


8

Compan

name

Director

pa 1979

1980

Lead ex-

ecutie actual

total

earning

20092011

Total

earning

increae

1980

2009/11

Top pa a

multiple of

aerage pa

19791980

Lea

ear

Lonmin 224938 1865342 729.3 44.1

BP 143334 4452624 3006.5 16.5

Barclas 87323 4365636 4899.4 14.5

GKN 81000 1534221 1794.1 14.9

LlodsBanking

Group

79344 2572000 3141.6 13.6

Reed Elsevier 75209 2028108 2596.6 13.3

Table 1 COMPANy PAy DATA IN UK LIsTED COMPANIEs 197920111

During the last 30 ears rewards have

been ooding upwards, with far moremodest returns going to the averageemploee. Since the mid 1970s, thegeneral workforces share of GDP hadshrunk b over 12% up to 2008.2

In UK companies toda, the pa gapbetween bosses and the averageemploee has grown dramaticall. In thelast ear alone, as economic growth hasslowed, executive pa in the FTSE 100rose on average b 49% compared withjust 2.7% for the average emploee.

Gross inequality

Since the nancial crisis of 2007 we

have seen the foundations of the currenteconomic model shaken to the core.

There is now a strong sense of injusticeat the fact that those at the top of ourcompanies continue to reap signicant

rewards, while the wages of man ordinarworkers are cut in real terms and theirjobs become more uncertain. Since 2007,a million more people are unemploed,the workless household rate has increasedb 5% and nearl a million oung peopleaged 1624 are on the dole.3

Executive

summaryThe High Pa Commissions ear-long inquir into pa at the top of UKcompanies has found evidence thatexcessive high pa damages companies,is bad for our econom and has negativeimpacts on societ as a whole. At itsworst, excessive high pa bears littlerelation to compan success and is

rewarding failure.

This distortion creates an impressionthat business leaders are in it forthemselves and is damaging trust inBritish companies, especiall at a timewhen most workers are seeing little or noincrease in their pa.

We have found that decisions leading toescalating high pa for senior executivesare often concealed from shareholdersand the public within complexremuneration arrangements, buried in thesmall print of companies annual reports.This lack of transparenc adds further

to the impression that senior companexecutives are rigging the sstem fortheir own ends.

Our ndings also show that the argument

used by many senior gures in British

business, that pa must escalate in orderto attract the best talent from abroadto UK companies, is a mth. Our ownevidence shows that global mobilit islimited, with onl one successful FTSE100 chief executive ofcer poached in

ve years and even this person was

poached b a British compan.

This report, the nal report from the

High Pa Commission, makes 12recommendations to address what we seeas a crisis at the top of British business.We believe it is time to act to buildtransparenc, accountabilit and fairnessinto remuneration for senior executives inthe UK.

Previously unpublished gures show that

pa at the top has spiralled alarmingl tostratospheric levels in some of our biggestcompanies. In BP, in 2011 the leadexecutive earned 63 times the amountof the average emploee. In 1979 the

multiple was 16.5. In Barclas, top pa isnow 75 times that of the average worker.In 1979 it was 14.5. Over that period,the lead executives pa in Barclas hasrisen b 4,899.4% from 87,323 to astaggering 4,365,636.


6/38


10

Distorting themarket

Further, our investigation has found

that top pa is a smptom of marketfailure based on a misunderstanding ofhow markets work at their best. Withincompanies, fair pa matters. It affectsproductivit, emploee engagement andtrust in our businesses. Pa in publicllisted companies sets a precedent; whenit is patentl not linked to performance,or rewards failure, it sends out the wrongmessage and is clearl a smptom of apoor functioning market. In addition, highlevels of inequalit in income contributeto sectoral imbalances, regional disparitiesand asset bubble ination.

Between 1998 and 2007, 60% of the

rise in overall income share of the top10% went to nance workers. It is not

surprising, then, that man talentedindividuals chose to make their career inthe Cit.5 Not surprising, also, that thiseconomic imbalance has drawn talentawa from other sectors.

Creatinginstability

But top pa is also a stor about the

health of societ. More unequal societieshave lower levels of social mobilit.6Indeed, when the gap between the havesand have nots becomes so large, it doesnot encourage aspiration or cohesion,but disengagement and social unrest.Academics warn that inequalit can leadto political instabilit, with poorer groupspursuing their economic objectivesoutside the mainstream.

Our inquir has found that we arenow at a tipping point where companreputations hang in the balance, and oureconom and societ is undermined ballowing the situation of excessive high

pa to persist.

Although this must ultimatel be alonger term endeavour as businesses,politicians and the public engage, it hasbecome clear that our starting point inseeking these solutions should be basedon the ke principles of transparenc,accountabilit and fairness.

Against this backdrop, the growing pa

gap with rewards meted out to those atthe top, often for failure, has increaseda public disillusionment and distrustof business. When executive rewardsseem to go beond what is linked to thatexecutives contribution to the successor welfare of the compan, it damagespublic trust and contributes to anattitude that business leaders are in itfor themselves.

The proposed increase during therecession in the salar of Sir MartinSorrell of 50% from 1 million to1.5 million, after he has said thatinequalit, the concentration of wealth

is a serious issue, reinforces the view ofthem and us. For business, there is noquick x. Trust takes time to build and

is easil damaged.

Employee engagement is a signicant

determining factor in business successand research suggests that pa equitinuences aspects of lower-level

emploee motivation, commitmentto management goals, effort andcooperation. In a surve of executivesgloball, 84% said that disengagedemploees are one of the three biggestthreats facing their business.4

Damaging trust

Our inquir has also found that pa is too

often seen as an opaque and specialisedpart of compan behaviour isolatedfrom the rest of the business. yet theaws our investigation have highlighted

in corporate governance, boardroombehaviour and the mismanagement ofpower inherent in placing control in thehands of an increasingl disparate rangeof owners do not simpl appl to pa.

We have also found attempts tocamouage executive pay. Ever more

complicated pa arrangements hiddenwithin reams of remuneration reportsappear designed to obfuscate as muchas the reveal. This lack of clarit

and decline in transparenc, fromshareholders and owners of businessesas well as from the public, encourages asense of distrust when the truth comesout, as it so often does.

Hidden from view

4 Economist IntelligenceUnit (2010) Re-engagingWith Engagement: views

from the boardroom onemploee engagement,www.businessresearch.eiu.com/sites/businessresearch.eiu.com/les/LON%20-%20PL%20-%20Ha%20report_WEB.pdf.


7/38


12

The High PayCommissionsrecommendations

TRANSPARENCy

1 Pa baic alarie to compan executie

The High Pa Commission believes papackages have become increasinglcomplex, damaging relations withshareholders, creating misperceptions andencouraging confusion and obfuscation. Wetherefore call for executive pa to return torst principles. We recommend executie

hould be paid a baic alar, with

remuneration committee electing to award

one additional performance-related element

onl where it i abolutel necear.

2 Publih the top ten executie pa

package outide the boardroom

The High Pa Commission believes thatlack of transparenc in pa directl belowboard level hides both the impact ofballooning top pa on other executivesand its link to performance. We thereforecall on all companie to publih an

anonmied lit of their top ten highet

paid emploee outide the boardroom.

3 standardie remuneration report

The High Pa Commission has foundremuneration reports to be complex,making pa packages and awards opaque

and unclear for shareholders and thepublic. We recommend that remunerationreport hould be preented in a

tandardied format, incorporating and

moing beond bet practice. A part of

thi we recommend that all companie

publish a gure for the total remuneration

package receied b each executie and amethodolog for how it ha been calculated.

4 Reuire fund manager and inetor to

dicloe how the ote on remuneration

The High Pa Commission acknowledgesthat, while the current model allowsshareholder absolute oversight of theexecutive through voting rights at theannual general meeting, some investmentfund managers full disclose how thevote on corporate governance while otheronl disclose this information to clients.We therefore call on all inetment fund

manager to full dicloe how the ote on

all iue including thoe of remuneration.

ACCOUNTABILITy

5 Include emploee repreentation on

remuneration committee

The High Pa Commission has foundremuneration committees to be a closedshop, made up largel of current andrecentl retired executives. This model hasfailed, leading to spiralling pa. We believethat greater engagement with emploeesma help restrain executive pa and helpmitigate negative impacts on morale aswell as encourage a greater engagement

with the workforce. We therefore callfor emploee to be repreented on

remuneration committees as a rst step to

better engagement and accountabilit.

Nick Clegg, Deput Prime Miniter and Leader of the Liberal Democrat

I think some of them [pa awards] are incomprehensible and will strike

most people as a slap in the face for millions of people who are on normalincomes and struggling to make ends meet.

Too often there isn't enough accountabilit. Shareholders don't knowwhat's going on and how these decisions have been arrived at and cruciallthere isn't a close enough relationship between high pa for people at thetop and the performance of the compan itself.7

Ed Miliband, Leader of the Labour Part

After calling for emploee representation on the remuneration committeesof all publicl listed companies in his Labour Part Conference speech2011 Ed Miliband stated more recentl that: when people are struggling,when the middle is being squeezed, when people are seeing their livingstandards fall, it is not fair for those at the top to get runawa rewards notrelated to the wealth the have created.8

7 Nick Clegg (2011) http://www.bbc.co.uk/news/uk-politics-155030608 Ed Miliband (2011)http://www.labour.org.uk/directors-pa-shows-wh-econom-needs-to-change,2011-10-28

Prime Miniter Daid Cameron, Leader or The Coneratie Part

On 27 October 2011, Prime Minister David Cameron said, Everone, whetherthe are in public life, whether the are in private enterprise, theve got to beable to justif the decisions the make about pa.

He said pa decisions should be published, and transparenc improved. Boardsshould also be more accountable to shareholders and consider the widerimplications of their actions: Boards have got to think when the make pa awardsif it is the right and responsible thing to do I believe in a responsible societ,and that is responsibilit exercised b everbod, including in the boardroom.


8/38


14

10 Reduce conicts of interest of

remuneration conultant

The High Pa Commission has foundthat, despite codes of conduct,remuneration consultants are found tocross sell services to companies, givingthem a direct conict of interests. This

may be having an inationary effect on

pa. We therefore recommend, in therst instance, that companies publish

the extent and nature of all the erice

proided b remuneration conultant,

acknowledging this is only the rst step if

cro elling i een to continue.

FAIRNESS

11 All publicl lited companie houldproduce fair pa report

The High Pa Commission believes thatit is essential that the pa gap betweenhighest paid and the compan medianshould be open to scrutin, includinghow the ratios of highest to median pahas changed over a three-ear period. Ifcompanies produce a fair pa report itwill allow them to state their principlesin relation to pa, encouraging pa to beconsidered across the compan whensetting executive pa, as is required bthe UK Corporate Governance Code.We recommend that all publicl lited

companie hould publih fair pa reporta part of their remuneration report to

build trut in pa policie.

12 Etablih a permanent bod to

monitor high pa

Our investigations have found thatescalating high pa is having a negativeimpact on compan performance, thewider econom and trust in business.We have been shocked at the limitedinformation available to the public, theconsequent lack of informed publicdebate and the deep sense of unfairnessthat this lack of openness engenders. Werecommend that a permanent bod be

etablihed on a ocial partnerhip bai,

much like the Low Pa Commiion b

goernment to:

monitor pa trend at the top of the

income ditribution police pa code in UK companie

enure compan legilation i

effectie in enuring tranparenc,

accountabilit and fairne in pa at

the top of Britih companie

report annuall to goernment and

the public on high pa.

8 Improe inetment in the talent pipeline

The High Pa Commission has found thatthe growing trend in hiring from outsidethe compan is having an escalatoreffect on executive pa. We recognisethat seamless succession is not onlimportant to compan performance, buthas a positive limiting effect on pa. Wetherefore recommend that companie

implement a dened and structured

talent pipeline to enure uitable and

qualied successors are promoted from

within the compan where poible.

9 Adertie non-executie poition

publicl

The High Pa Commission recognisesthat the makeup of non-executivedirectors, who determine executive padeals, may have an inationary effect on

pa. Even looked at positivel, these non-executives are drawn from a relativelsmall pool of individuals. We beliee therecruitment of non-executie hould be

openl adertied, making remuneration

committee open to a wider group,

encouraging dierit and ending the

cloed hop culture of appointment.

6 All publicl lited companie hould

publih a ditribution tatement

The High Pa Commission has foundthat man shareholders have a low levelof engagement on issues of executivepa. It is important now to encouragegreater engagement through improveddisclosure, which takes greater accountof the compan context. We thereforerecommend that all publicl lited

companie publih annuall a tatement

of the ditribution of income oer a

period of three ear, importantl howing

percentage change in:

total taff cot

compan reinetment

hareholder diidend

executie team total package

tax paid.

7 shareholder hould cat forward-looking

adior ote on remuneration report

The High Pa Commission has consideredrecommending making shareholdersadvisor votes on remuneration reportsbinding, but it was felt that a preferredoption at this stage would be to makethe vote forward looking. We thereforerecommend that hareholder ote on

remuneration are cat on remuneration

arrangement for three ear followingthe date of the ote and that thee

arrangement include future alar

increae, bonu package and all hidden

benets, giving shareholders a genuine

a in the remuneration of executie.


9/38


16

alone executive pa rose b 49% on

average in FTSE 100 companies. Thisis juxtaposed with average emploeeshaving an increase in pa of just 2.7% inthe same ear.13

As this report shows, over the past 30ears there has been enormous growthin pa at the top of some of our biggestcompanies. In BP total pa of executiveshas increased b 3006%, while overthe same period average pa in BPhas increased b just 713%. The ratiobetween the average pa of executivesand that of workers has grown from 16to 63. While data going back this far israre, the picture repeats itself in all the

companies on which we were able toacquire information (see annex 3).

This trend has characterised the last 30ears of economic activit in the UK.Yet it took the nancial crisis in 2008

to throw it into stark relief. In doingso it forces us not onl to look at whathas happened to top pa but also toinvestigate what is driving it.

The growth in top pa has not taken place

in isolation. It demonstrates the dominanceof a particular form of capitalism inthe UK and an elevation of the conceptof the rational self-interested man tounprecedented heights.

In this environment human nature,aspiration and endeavour are seen through aprism of self interest, or as some would putit greed as ever larger rewards are requiredto generate performance from individuals atthe top of companies whose predecessorsbut a generation ago did the job for a tenthof the pa. yet top pa is not onl a smptomof a particular form of capitalism but is alsocontributing to man of the problems we see

in our econom, societ and companies.

As has been argued b others, markets donot occur in isolation; the are embeddedwithin broader societ.14 The rstcompanies were licensed to trade b thestate and that inter-dependence and theidea of permission to trade underpinnedcompan activit until the late 1970s.15

Companies served a wide constituenc consumers, clients, emploees and thebroader public good. A compan was inpartnership with societ.

Even toda publicl listed companies

are still licensed b the state to operate.The depend on the roads, railwa lines,infrastructure, an educated workforce anda willing clientele, and equall the haveresponsibilities to the countries the work in

Drivers of payat the top: thecontext1|

IntroductionYou have to realise: if I had been paid 50% more, I would

not have done it better. If I had been paid 50% less, then I

would not have done it worse.

Jeroen van der Veer, Former CEO of Roal Dutch Shell9

Over the past ear the High PaCommission has investigated a sustainedtrend in income distribution: since thelate 1970s there has been a signicant

shift in income share, with a growingpercentage going to the ver top.

This ballooning in pa at the top hasaccompanied a dramatic growth inincome inequalit, which if it continuesunchecked will take us back to Victorianlevels of pa inequalit in less than 30ears.10

No longer the landed gentr nor the

successful entrepreneur, the majorit ofthis wealth elite are now the workingrich;11 bankers and business leaders areproting the most from this upwards

redistribution and it is primaril takingplace in the private sector.12

In our companies the pa gap betweenthe bosses and the average emploeehas grown. Starting in the earl 1980sa shift occurred in which pa at the topincreased exponentiall. In part thisgrowth was driven b a desire to link pato performance to tie the interests ofthe executive to the shareholders andcreate quasi-entrepreneurs at the topof our businesses. yet despite theseattempts to link pa to performance,rewards for failure continue andpa levels appear to be increasingldisconnected from the performance ofthe compan.

Toda, as economic growth slows andman workers experience wage freezes,those at the ver top have experiencedno such hardships. Indeed, their pahas continued its meteoric rise: in 2010

9 C. Hoos and M. Steen(2009) Shell chiefcalls for pa reforms,Financial Times, 8 June,www.ft.com/cms/s/0/d8ed7afa-5458-11de-a58d-00144feabdc0.

html#axzz1aGcstydP.10 High Pa Commission(2011) More for Less:what has happenedto pa at the top anddoes it matter?, http://highpacommission.co.uk/wp-content/uploads/2011/09/HPC-IR.pdf.11 T. Pikett and E. Saez(2006) The evolution oftop incomes: a historicaland internationalperspective, NBERWorking paper No.11955.12 Public sector emploeesaccount for less than1% of the top 1% of theincome distribution scale.This was acknowledged

in the government inquirheaded b Will Hutton,which looked at high pain the public sector. It isfor this reason that theCommission has focusedits attention on the privatesector.


10/38


18

position. It is against this backdrop that

the High Pa Commission has beenconducting its investigation into top pa.

Since 2007 a million more people areunemploed, the workless household ratehas increased b nearl 5% and nearla million oung people aged 1624 arereceiving jobseekers allowance.17 Andet those at the top of our companiesand banks continue to reward themselvesastronomicall high salaries and bonuses.

This report makes clear that the growingpa gap, rewards meted out to those atthe top while everone else suffersausterit Britain and rewards for failure

that have characterised recent earsare no longer tenable. Fairness mattersto individuals, societ, companies andthe wa successful economies operate.Without fairness and trust businesscannot function properl.

People at the top are like everone else.The are not a breed apart. The aremotivated b status considerations asmuch as b pa.18 The want to be likedand respected b their peers. The havestandards of professional ethics. Creatinga vision and living b values is what getsthem out of bed in the morning. yet noneof this is acknowledged in the wa we pa

them. Indeed pa structures for those atthe ver top are based on the assumptionthat people at the top need to berewarded to excess to persuade them todo their job.

Quite simpl we have been paing toomuch and getting too little, as our interimreport More for Lessargued.19

If we continue in this wa we willincentivise the wrong behaviours,continue to fail to match pa toperformance, mis-read what makes asuccessful compan tick and damage thestanding of business in the publics ee.

The public have a visceral sense offairness and top pa stands in starkcontrast to it. Talented individuals shoulddo well; the public do not grudge greatmusicians their rewards, and the risk-taking entrepreneur is seen in a different

light from a compan man or investmentbanker who experience onl the upside oftheir gamble.

As pa at the top rises, so too doesdisillusionment and distrust of businessamong the public. It is evident in theprotests against tax avoidance, and in theperson-in-the-streets disgust that thosewho got us into the current economicsituation are not sharing the pain of it.Sustaining these levels of unjustiably

high pa shows that we are reall not allin this together.

In the late 1970s the old corporatism

was fading and a new more rational formof capitalism was urged on the world beconomists such as Milton Friedman fromthe Universit of Chicago. These thinkersargued that economies, and the companieswithin them, should be freed from the rigidexchange controls and trade barriers thathitherto had been a dominating part of theeconomic landscape.

Freeing capital to move around theworld would help companies grow faster,and adapt more energeticall to newopportunities; thus we would all benet.

The compan, as we know it toda, focusedon short-term shareholder value was born.

It was argued that to achieve thenecessar dnamism those at the top ofcompanies must be incentivised, andtheir interests must be tied to those ofthe shareholders. Nothing should stopthose capable of generating wealth fromso doing. That wealth would then trickledown to the rest of societ as the wealthcreators spent their rewards, created newjobs, started new companies. After all, itwas argued, if free to do so, people willalwas make rational economic decisionsbased on self-interest.

Paing the best more and taxing the high

paid less became a cornerstone of thiseconomic argument. The wealth creatorsneeded to be freed to create wealth, andif the were not properl rewarded themight go off and do something else withtheir talents, somewhere else.

For the last 30 ears those at the top

have seen their pa explode. Rewardshave literally ooded upwards with farmore modest returns going to the averageemploee. Indeed, since the mid 1970s,the general workforces share of GDP hadshrunk b over 12% up to 2008.16

Since the nancial crisis of 2007

we have seen the foundations of thiseconomic model shaken. A new publicmood seems apparent, one that feel avisceral sense of injustice at the fact thatwhile their wages are cut in real termsand their jobs become more uncertain,those at the top of our companiescontinue to reap signicant rewards.

This sense is exacerbated b a publicanger at the bankers who are seenby many as culpable for the nancial

crisis. Moreover, the nancial crisis

demonstrates the extent to whichcompanies and those who lead themhave become disconnected from theconsequences of their actions. FredGoodwin was an exception: few ofthose at the top of our companies feltthe cost of their actions; indeed evenFred Goodwin left RBS with a generouspension package.

In this light, private companies can no

longer be seen as autonomous separatebodies that should be left untouched bregulation. There is a growing consensusthat the foundations of our econom mustchange and that the over reliance on theCit of London is no longer a sustainable

16 J. Plunkett (2011)Growth withoutGain. ResolutionFoundation http://www.resolutionfoundation.org/media/media/downloads/Growth_without_gain_-_Web.pdf p23.


11/38


20

nance to private equity, and private

equit to footballers each proclaimingthe other is where the problem lies. yetthe dramatic escalation of executivepay is cause for specic concern in our

companies and for our econom.

Fair pa within companies matters;it affects productivit, emploeeengagement and trust in our businesses.Moreover pa in publicl listed companiessets a precedent, and when it is patentlnot linked to performance, or rewardsfailure, it sends out the wrong messageand is a clear smptom of market failure.

Within the business communit there is a

blame game going on. Talk to executivesand the problem is shareholders; talkto shareholders and the problem isnon-executive directors; non-executivedirectors in turn blame the executivefor demanding too much; and everoneblames remuneration consultantsfor making the whole sstem toocomplicated.

This blame game, however, cannotcontinue indenitely as there is a growing

public disquiet, which threatens to boilover into anger. Business leaders thosewho can invest and help us grow out ofthis crisis are seen as being on a par

with estate agents in the degree of publictrust the inspire. That, in the words ofJohn Cridland, Director General of theCBI, the business lobb, is not a goodspace to be in.22

Business leaders universall recognise

that emploee engagement is essentialfor a successful compan and et thefail to recognise the negative impact onengagement caused b their own pa. Themore thoughtful and engaged corporateexecutives recognise there is a problemwith pa, but feel unable to combatit from within the are trapped n asstem the do not believe works. Time isrunning out. The public demands changeThe econom needs change.

Businesses must take a lead on this issueand elect to introduce the changes incompan practice we recommend. Butgovernment must act too. Government

should introduce the changesrecommended in the report; use its poweras a purchaser; and set a tax regime thatincentivises the sort of behaviour that leadsto market success and not market failure.

It took 30 ears to reach this point ofpa excess. Even with the best ambitionsit ma take that long to resolve. Thisproblem goes deep. It is a smptom of aparticular form of free market capitalismand we should recognise that no singleset of polic recommendations will resolveit. Business must work with government,trade unions and civil societ to addressthis problem over the longer term.

It is no longer possible to contest the factthat there has been an enormous upwardredistribution of income since the 1980sOnl one question remains what do wedo about it?

Top pay as a symptom ofmarket failure

Too often pa is seen as a rather opaque

and specialised part of a companisolated from the rest of businessbehaviour. yet it is through looking atexecutive remuneration that we see theclassic problems of corporate governancelaid bare. Nowhere do the conicts of

interest in corporate governance lie soclose to the surface.

Our investigation has highlighted theaws in remuneration committees, the

extent of management power and thechallenges inherent in placing all controlin the hands of an increasingl disparaterange of owners. Top pa is a smptomof a wider market failure based on a

misunderstanding of how markets workat their best. Though we have onl lookedat high pa, we have been cognisant ofthis broader debate and acknowledge thatour recommendations are part of a widersolution that would see a new, fairer,more sustainable and more vibrant formof capitalism.

Furthermore, the economic damagefrom over-paing at the top and under-paing everone else goes wider. Highlevels of inequalit in income are seento contribute to sectoral imbalances,regional disparities in investment andasset bubble ination.

In the current economic environmentpa becomes ever more important. It isargued that extremes in pa distributionare dampening our abilit to grow out ofthe crisis. When a bigger and bigger slice

of corporate prot is going to a select

group of people who invest in safe assetsor commodities (often in other parts ofthe world), rather than spend their moneon goods and services here, economicgrowth in the UK is stunted.

But top pa is also a stor about thehealth of societ. The social impactof gross inequalit has been wellinvestigated from the earl work of SirMichael Marmot, and the WhitehallStudy, to the more recent ndings or

Richard Wilkinson and Kate Pickett inThe Spirit Level.20 While there is somecontroversy over their ndings, which

the have robustl rebutted in peer

reviewed journals, there seems to belittle doubt that gross inequalit affectsmorbidit and mortalit rates, includinginfant mortalit rates. More unequalsocieties also have lower levels of socialmobilit. As Conservative Minister Rt HonDavid Willetts MP has stated, Westernsocieties with less mobilit are the oneswith less equalit too.21

Over the past 30 ears, most peoplesupplemented their incomes throughcredit and paper wealth in the form ofequit in propert. This has now gone as the pendulum swings the other warestricting credit to all but the safest of

applicants and spending will remainslow as pschological povert persists.

As pa escalates for those at the top itcreates a new point of comparison anew norm. Executives look to nance,

20 See www.ucl.ac.uk/epidemiolog/people/marmotm.htm; Wilkinson

and Pickett, The SpiritLevel.21 Quoted in Viewpoint:wh the class struggleis not dead (2011)BBC News, http://www.bbc.co.uk/news/uk-politics-14721315.


12/38


22

Compan nameDirector

pa 1979

1980

Total earn-

ing increae1980

2009/11

(%)

Lead

executieactual total

earning

2009

2011

Top

pa a

multipleof aerage

pa

1979

1980

Incre

in

aerapa

198

2009

(%

Lonmin 224938 729.3 1865342 44.1 223

BP 143334 3006.5 4452624 16.5 713

Barclas 87323 4899.4 4365636 14.5 865

GKN 81000 1794.1 1534221 14.9 491

Llods BankingGroup

79344 3141.6 2572000 13.6 487

Reed Elsevier 75209 2596.6 2028108 13.3 834

Table 2COMPANy PAy DATA IN UK LIsTED COMPANIEs 1979201125

Wh doe fair pa matter to companie,

the economy and society? In the interimreport we identied the broader impacts

of high levels of pa inequalit onsociet, businesses and the econom. Inthis nal report we want to look at these

more closel.

2|Is the food

to the top aproblem?

Over the last 30 ears as our interimreport More for Lessdemonstrated wehave seen a dramatic shift in incomedistribution. Those at the top have donever well with the top 0.1% seeing themost signicant growth, followed closely

b the top 1% and top 10%:

In 1979 the top 0.1% took home1.3% of the national income; b 2007this had grown to 6.5%.

In 1979 the top 1% took home5.93% of the national income; b2007 this had grown to 14.5%.

In 1979 the top 10% took home28.4% of the national income; b

2007 this had grown to 40%.23

In our companies, we see this trendrepeated. While the data going back to1979 is limited, in all the companiesfor which data was available we foundenormous growth in pa at the top, andwe provide the gures in Table 2 as an

indicative picture of what has happenedacross FTSE companies. Indeed in thelast ten ears alone average total pafor the lead executive in the FTSE 350companies has increased b 108%. Theaverage FTSE 100 CEO is estimated totake home 4.2m.24

23 F Alvaredo et al. (n. d.)The World Top IncomesDatabase, http://g-mond.parisschoolofeconomics.eu/topincomes.24 IDS (2010) DirectorsPa Report


13/38


24

TOP 0.1% sHARE OF NATIONAL INCOME.

UNITED KINGDOM As COMPARED WITH

THAT OF OTHER COUNTRIEs 2002-2009

See Anne

USA

FRANCE

SW

ITALY

INDONESIA

CHINA

SOUTH AFRICA

UK

JAPAN

2003 2004 2005 2006 2007 2008 2

0%

2.5%

7.5%

5.0%

2002

By 2035 THE TOP 0.1% WILL TAKE HOME 14% OF THE NATIONAL

INCOME. EqUIvALENT TO THAT sEEN IN vICTORIAN ENGLAND.

See Annex 3 for source referencing

TOP 0.1% sHARE OF NATIONAL INCOME IN

THE UNITED KINGDOM 1900-2035

190

3

191

1

191

9

192

7

193

5

194

3

195

1

195

9

196

7

197

5

198

3

199

1

199

9

200

7

201

5

202

3

203

1

0

3.75

7.50

11.25

15.00

1978

1.24% of

National

Income

2035

14% of

National

Income


14/38


26

Research suggests that pa equit

will inuence aspects of lower-levelemploee motivation commitmentto management goals, effort andcooperation:

Lower-echelon emploees who feeldisadvantaged are less supportive ofthe goals of the over-rewarded group.33

Individuals who believe theare treated fairl have a strongeridentication with their company, so

the internalise the goals promoted bmanagers.34

A sense of injustice createsinterpersonal resentment, whichweakens afliated emotional bonds

between organisation members andthus reduces their willingness tocooperate.35

It is commonl recognised that emploeeengagement remains one of the mostsignicant determining factors in

business success (see box 1). In asurve of executives globall, 84%of respondents said that disengagedemploees are one of the three biggestthreats facing their business.36

Emploee engagement is affectedb several factors, including working

conditions, opportunit, managementand pa. Fair pa within a companis an important plank in creating anenvironment where emploee engagementcan thrive.37

30 J. Pfeffer and N.Langton (1991) Wagedispersion, satisfaction,and performance:

evidence from collegeadministrators,unpublished manuscript,Graduate School ofBusiness, StanfordUniversit.31 D. Cowherd andD. Levine (1992)Product qualit andpa equit betweenlower-level emploeesand top management:an investigation ofdistributive justice theorAdministrative ScienceQuarterl 37(2): 30220.32 P. Martins (2008)Dispersion in wagepremiums and rmperformance, EconomicsLetters 101: 6365.33 E. Hateld and S.

Sprecher (1984) Equittheor and behavior inorganizations, in S. B.Bacharach and E. J.Lawler (eds), Researchin the Sociolog ofOrganizations 3, JAIPress, 95124.

2.1 The businesscase for fair pay

The Financial Reporting Council

(FRC) UK Corporate Governance Codestates that when setting executivepa the remuneration committee of acompan should be sensitive to pa andemploment conditions elsewhere in thegroup, particularl when determiningannual salar increases. This is includedin the code because of a recognition thatpa in companies matters.

Indeed the Association of BritishInsurers (ABIs) revised code on papublished in 2011 recognises thesignicance of large pay awards, stating

Excessive or undeserved remunerationundermines the efcient operation of the

compan, adversel affects its reputationand is not aligned with shareholderinterests.26

There is a strong case for companies totackle the growing pa gap to enhance ormitigate:

emploee engagement

reputational harm

trust in businesses.

WHy DOES PAy MATTER WITHINCOMPANIES?

It is classicall argued that peoplessense of fairness within an organisationis based on whether the believe theirpa is fair in relation to similarl paidemploees.27 However, this has been

challenged. Academics Martin and Crosb

nd that individuals also experiencea sense of relative deprivation whenthe compare their rewards with thosereceived b higher status individuals.28

A series of studies show that withinan organisation lower strata memberscompare their rewards not just withthose of their peers, but with therewards received b upper-strata groups,and that where the gap is signicant

these comparisons result in feelingsof injustice.29 Injustice in turn erodesengagement. In a stud of universitdepartments Pfeffer and Langton foundthat employees were more dissatised

where there was greater salardispersion, even when pa was relatedto inputs such as productivit andexperience.30

Companies are not simpl places wheregoods and services are produced; theare also hotbeds of social comparison.It is for this reason that the qualit ofwhat is produced, the service providedand ultimatel the success of thebusiness is determined not simpl bthe best chief executive ofcer (CEO)

but b the motivation of emploees.Motivation it is argued is affectedb social comparisons, including

those with executives who receive fargreater rewards in exchange for theircontributions.31

Within-rm pay inequality is associated

with lower-rm performance.32

26 ABI Principles ofRemuneration (2011)www.ivis.co.uk/

ExecutiveRemuneration.aspx.27 J. Martin (1981)Relative deprivation:a theor of distributiveinjustice for an era ofshrinking resources, inB. M. Staw and L. L.Cummings (eds) Researchin Organizational Behavior3, JAI Press, 53107.28 Ibid.; F. Crosb (1984)Relative deprivation inorganizational settings,in B. M. Staw and L. L.Cummings (eds) Researchin Organizational Behavior6, JAI Press, 5193.29 J. Martin, Relativedeprivation; J. Martin(1982) The fairness ofearnings differentials:

an experimental stud ofthe perceptions of blue-collar workers, Journalof Human Resources 17:11022; J. Martin (1986)When expectations andjustice do not coincide,in H. W. Bierhoff, R. L.Cohen and J. Greenberg(eds) Justice in SocialRelations, Plenum,31735; J. Martinand A. Murra (1983)Distributive injusticeand unfair exchange,in D. M. Messick andK. S. Cook (eds), EquitTheor: pschological andsociological perspectives,Praeger, 169205; J.Martin et al. (1987)Now that I can have it

I'm not so sure I want it:the effects of opportuniton aspirations anddiscontent, in B. A.Gutek and L. Larwood(eds), Women's CareerDevelopment, Sage,4265.


15/38


28

TRUST IN BUSINESS

Trust in business has clearly eroded and needs to be

reconstructed. Its very dangerous if a country doesnt trust

the private sector

Andrew Witt, CEO of GlaxoSmithKline49

As well as motivated and engaged staff,successful businesses rel on a supportivepublic. It is therefore concerning thatlevels of trust in business are so low(see box 2). While some academicsspecialising in corporate ethics havegone so far as to describe the role thatcompensation plas in damaging publictrust in corporations as central, it is fair

to describe it as a contributing factor.

When executive rewards seem togo beond what is linked to theircontribution to the success or welfare ofthe compan, it damages public trust andcontributes to an attitude that businessleaders are in it for themselves.50

Indeed this feeling is onl exacerbatedwhen a 50% pa rise is proposed fora high-prole business leader such as

Sir Martin Sorrell, chief executive andfounder of media giant WPP, who hadpreviousl stated that inequalit, theconcentration of wealth is a serious

issue.51

The proposed award wouldincrease his salar from 1m to 1.5mat a time of recession. To the public thisreinforces a view of them and us thatbusiness leaders are prepared to saone thing and do another. It creates a

perception of arrogance that too mancorporate leaders have crossed intothe rst class lounge and are therefore

entitled to ever higher rewards for thesame or lower effort.

For businesses there is no quick x. Trust

takes time to build, and is easil damaged.

Taking the lead on resolving the currentescalation in executive pa is one wato begin to rebuild trust. Indeed asRichard Edelman, CEO of the World TrustBarometer, writing in the Financial Timesstated that in order to restore trust:

CEOs must demonstrate that

the burden of the recession.

many people are losing jobs

are seeing stock values plum

executive pay cuts and forfeisend a powerful message tha

tune with the realities facing

bOX 1 THE IMPORTANCE OF EMPLOyEE ENGAGEMENT38

Buine growth:

Towers Perrin-ISR found a gap of 52% between companies withhighl engaged emploees and companies whose emploees had lowengagement scores in the improvement in operating income over theear.39

A Gallup stud showed that growth rates for businesses with high-

engagement workforces were 2.6 times those for low-engagementbusinesses.40

Additionall a separate Gallup stud showed those with engagementscores in the top quartile averaged 12% higher customer advocac and18% higher productivit.41

Buine ucce:

A Watson Watt stud of 115 companies suggested that a companwith highly engaged employees achieves a nancial performance

four times greater than companies with poor engagement. It alsoreported in 2008/9 that the highl engaged are more than twice aslikel to be top performers almost 60% of them exceed or far exceedexpectations for performance.42

In a report for the Institute for Emploment Studies, Barber, Hadaand Bevan concluded that a 1% increase in emploee commitment

(using a ve point scale) can lead to a monthly increase of 9% insales.43

A Gallup stud showed that companies with engagement scores in thetop quartile averaged 12% higher protability.44

Accident:

A stud b Gallup showed companies with engagement scores in thebottom quartile averaged 62% more accidents than those in the topquartile.45

staff turnoer:

The Corporate Leadership Council in 2008 reported that high-engagement organisations can reduce staff turnover b up to 87%.

A Gallup stud showed that those with engagement scores in thebottom quartile averaged 3151% more emploee turnover.46

staff ickne abence: Engaged emploees in the UK take an average of 2.69 sick das

per ear; the disengaged take 6.19.47 The CBI reports that sicknessabsence costs the UK econom 13.4 billion a ear.48

38 Based on the nding ofDavid Macleod and NitaClark. See D. Macleod

and N. Clarke (2009)Engaging for Success:enhancing performancethrough emploeeengagement, Departmentfor Business Innovationand Skills, www.bis.gov.uk/les/le52215.

pdf. These points werealso raised in W. Hutton(2011) Hutton Reviewof Fair Pa, HM Treasur,www.hm-treasur.gov.uk/d/hutton_fairpa_review.pdf.39 Towers Perrin-ISR(2006) The ISR EmploeeEngagement Report.40 Gallup Organisation(2006) Engagementpredicts earnings pershare. Referenced inMacleod and Clarke,

Engaging for Success.41 J. K. Harter et al.(2006) Gallup Q12 Meta-Analsis.42 Watson Watt (2008)Continuous Engagement:the ke to unlockingthe value of our peopleduring tough times,WorkEurope surve report20082009, http://www.watsonwatt.com/research/pdfs/2008-EU-0617.pdf.43 L. Barber, S. Hadaand S. Bevan (1999)From People to Prots,

Institute for EmplomentStudies.44 J. K. Harter et al.,Gallup Q12 Meta-Analsis.45 Ibid.46 Ibid.

47 Gallup report in 2003,cited in Melcrum (2005)Emploee Engagement:how to build a highperformance workforce.48 CBI-AXA (2007) AnnualAbsence and LabourTurnover Surve.


16/38


30

2.2 The economiccase for fair pay

Min Zhu, a special adviser at the

International Monetar Fund and a formerdeput governor of the Peoples Bank ofChina, told delegates at Davos:

Increasing inequality is

the biggest challenge the

economy faces for the whole

world not just advanced

economies We cannot

let the income disparities

increase further I dont

think the world is paying

enough attention.

The economic case for getting to gripswith the dramatic escalation in top pa isincreasingl apparent. Extreme levels ofpa inequalit have an impact on:

entrepreneurialism

growth

economic instabilit

sectoral imbalances

social mobilit.

ENTREPRENEURIALISM

Small businesses, new businessesand innovation are essential to the UKeconom. Small businesses emploing

bOX 3THE ENTREPRENEUR

Levels of entrepernerialism in thincreasing in recent ears as a rgovernment focus. However, onlworking population are involvedactivities. This gure is lower th

gures in the Netherlands, Norw

but higher than those in Spain a

Entrepreneurs are essential to eA recent OECD paper stated, It clear that entrepreneurship is imeconomic growth, productivit, iemploment.57

Studies have shown there is a rebetween patents per head of poequalit, suggesting that entreprand innovation ma be higher incountries.58

Entrepreneurialism is a high-risthe average personal investmenstanding at 7,000. This risk dindeed it is often exacerbated awith individuals mortgaging asse

less than 50 people account for 46%

of all private sector workers.54

yet it hasbeen argued that the growth in pa at thetop is discouraging entrepreneurialism.55

Indeed it makes sense to avoid takingthe risk: wh risk our own capital, ourfamil home, when the opportunit forindependent wealth awaits the companman or the banker?

This decline in trust is set against a

backdrop of a renewed public demand foraccountabilit among business leaders(see box 2). Whether this is politiciansor bosses there are new expectations onthose who lead.

bOX 2TRUsT IN BUsINEss

According to the Edelman Trust Barometer:

In the UK onl one-third of the public trustcompan executives.

The credibilit of the CEO as a trustedspokesperson is at an all-time low of 29% globalland 20% in the UK.

Trust in businesses to do the right thing fell in the

UK b 5% between 2009 and 2010 to 44%

The public expects companies to behave in theinterests of societ: 89% of respondents agreedthat corporations should create shareholder valuein a wa that aligns with societs interests, even ifthat means sacricing shareholder value.

There is further support for governmentintervention with 82% agreeing that governmentshould regulate corporations activities to ensurebusinesses behave responsibl.

Whether the public trusts a compan is now asimportant to the public as the products it produces.

REPUTATIONAL HARM

The growing public and press interest in theissue of executive pa increases the likelihoodof reputational harm. Business leaders riskdamaging their reputations and those of theircompanies as public anger grows over thesize of executive pa packages.

It is widel recognised that damage toreputation will ultimately hurt prot

margins, and can lead to public protests,like those carried out b UK Uncutagainst the Top Shop boss Sir PhilipGreens alleged tax avoidance.

This is exacerbated in times of austerit,

but fear of reputational harm, evenin good times, appears to have led toattempts to camouage executive pay.

Ever more complicated pa arrangements,hidden within reams of remunerationreports, appear designed to obfuscate asmuch as the reveal.53

This lack of clarit, encouraged in partb a fear of reputational harm, leads to adecline in transparenc, not just from thepublic but also from the owners of thebusiness, the shareholders, who struggleto determine what level of reward is beinggiven for what level of performance. Thisis inefcient and further encourages the

sense of public distrust when the actuallevels are disclosed in the press.

53 High Pa Commission,More for Less.


17/38


32

There is an equivalent of a Laffer curve for inequality, but th

of interest is economic growth rather than tax revenue. We k

society with perfect equality does not grow at the fastest po

When everyone gets an equal share of income, people lose

try and get ahead of others. We also know that a society wh

has almost everything while everyone else struggles to survi

unequal distribution of income imaginable will not grow a

possible rate either. Thus, the growth-maximizing level of in

lie somewhere between these two extremes.61

Indeed, the former chief economist at theIMF, Raghuram Rajan, has argued thathigh levels of inequalit contributed tothe nancial crisis. Rajan, in his recent

book Fault Lines, demonstrates that

high levels of wage ination at the topand wage stagnation for the rest of thepopulation led to a growth in eas credit.As the rich got richer and average wagesstagnated governments could not simplstand b as the poor and unskilled fellfarther behind.62

Roland Benabou, professor of economicsat Princeton Universit, further arguesthat high levels of inequalit do not leadto more efcient investments. The reason

for this is the existence of incompleteasset markets and liquidit constraints,which suggest that a reduction ininequalit ma lead the poor to carr out

more efcient investments.63

Thus, the allocation of investmentmay be more efcient under greater

equalit. Those on lower incomes willbe more likel to spend an important

fraction of additional wealth in healthand education-enhancing spending;it ma effectivel contribute morethan a rich famils savings to capitalaccumulation.64

Rajan also argues that in unequalsocieties the rich spend signicant

amounts tring to shape rules of thegame in their favour.65

Further work from academic Dani Rodrikhas provided empirical evidence thatunequal societies are less likel to carrout the adjustments necessar to respondto negative macroeconomic shocks.66

This is supported b academics Alesinaand Drazen, who demonstrate thatinequalit can be harmful to long runeconomic growth, making economic

reforms less likel. The argue thatinequalit can reduce the base ofsupport for fundamental structuraltransformations necessar to embark on apath of high growth.67

THE PROBLEMS WITH GROWTH

This inequality is destabilizing and

undermines the ability of the economy to

grow sustainably and efciently [ Income

inequality] is anathema to the social progress

that is part and parcel of such growth.

Sarah Bloom Raskin,

Board of Governors of the Federal Reserve Sstem

It has traditionall been argued that

inequalit is activel good for growth. Anenvironment where people are able to dover well is good for aspiration, drivingthe workforce to compete, and indeedhigher earners save more and so are morelikel to invest.

However, this classic post-Kenesianmodel is increasingl being challenged inlight of a growing bod of evidence whichsuggests that gross inequalit in incomecontributes to sectoral imbalances, regionaldisparities in investment and asset bubbleination. It has been argued that this

growth in inequalit results in higher levelsof investment in assets. This investment in

assets can encourage economic instabilitand increase the likelihood of shocks andnancial crises.59

In the current economic environment,

pa becomes ever more important andit is argued that extremes in incomedistribution are hampering our abilitto grow out of the crisis for the reasonscited above.60 High pa, wage inequalitand the suppression of wages forthe majorit is of course not the onlexplanation for the above economicevents, but it is a part of the puzzle.

It is increasingl recognised thatincome and wealth inequalit is havinga profound effect on our econom. Aseconomist Mark Thoma, of Universit ofOregon put it:

59 A. Alesina andD. Rodrik (1994)Distributive politicsand economic growth,Quarterl Journal ofEconomics 109(2):

46590; T. Perssonand G. Tabellini (1994)Is inequalit harmfulfor growth?, AmericanEconomic Review 84(3):60021; K. Forbes(2000) A reassessment ofthe relationship betweeninequalit and growth,American EconomicReview 90(4): 86987; R.Barro (2000) Inequalitand growth in a panelof countries, Journal ofEconomic Growth 5(1):532; A. Banerjee and E.Duo (2003) Inequalityand growth: what canthe data sa?, Journal ofEconomic Growth 8(3):26799.60 In stating that an

economic model basedon growth is desirable thecommission recognises thecurrent debate on whethergrowth is sustainable,and on whether analternative paradigm isnow necessar.


18/38


34

2.3 The socialcase for fair pay

Discussion on the social impacts of pa

inequalit has traditionall focused on theimpact of povert. How wage disparitiescreate povert traps and intergenerationalunemploment. How povert anddeprivation, even in a wealth countrsuch as the UK, still affect morbidit andmortalit rates. How povert ruins lifechances. yet this is onl half the stor.As it is not just pa at the bottom thatmatters, but pa at the top too.

Social comparisons do not just take placewithin companies; the occur acrosssociet. However, when the gap betweenthe haves and everone else becomes solarge it does not encourage aspiration or

cohesion but disengagement and socialunrest we have reached a tipping point.

The riots that started in London andspread across the countr in the summerof 2011 will over the ears be muchexamined and the causes much explored.But it should not perhaps surprise us thatthe rioters took the trappings of wealththat the could not afford the TVs anddesigner trainers. It reects a sense of

entitlement that pervades societ fromthe ver top to the bottom.

Inequalit does not come without economicand social consequences.75 The growing

gap between the top strata of societ andthe rest of the population has specic

effects, which it is relevant to discuss here.

INEQUALITy AND INSTABILITy

Nouriel Roubini, professor of economics atNew york Universit, warned that inequalitexacerbates political instabilit.76

It has been argued that inequalitcan lead poorer groups to pursuetheir economic objectives outside themainstream. This can lead to higherlevels of participation in violent politicalmovements, and social unrest.77

A report from the United Nations states,High levels of inequalit can lead tonegative social, economic and politicalconsequences that have a destabilising

effect on societies.78

As social mobilitrecedes so does opportunit. If opportunitis extinguished, unrest will surel follow.This, it is clear, is the lesson of histor.79

INEQUALITy AND INFLUENCE

The size of reward metered out to spivsand gamblers80 in the banking sstemnot onl represents but exacerbates atake what ou can get culture. As theArchbishop of Canterbur has arguedrecentl: Economic exchange is one ofthe things people do. Treat it as the onlreal thing people do and ou face thesame problems that face the evolutionar

biologist for whom the onl question ishow organisms compete and survive, orthe fundamentalist Freudian for whomthe onl issue is how we resolve thetensions of infantile sexualit.81

SECTORAL IMBALANCE

There are further concerns that highlevels of income inequalit are resultingin sectoral imbalance. Between 1998

and 2007, 60% of the rise in the overallincome share of the top 10% wentto nance workers. It is therefore not

surprising that man talented individualschoose to make their career in the Cit.68

The impact of this on the econom as awhole is not et known but Andrew Witt,CEO of GSK, discussing the nancial

sector stated: It drew out a huge amountof talented graduates. This impacts onour econom. If levels of pa in one sectordisproportionatel attract talent, this affectsour econom as a whole b withdrawing thetalent required for engineering, teaching,medicine, manufacturing and other wealth-

generating and sociall important industries.

High pay in the nancial sector has

had the effect of recruiting to a life ofnancial intermediation many who would

otherwise have gone into other careers.

SOCIAL MOBILITy

Social mobilit has alwas been highup the political agenda, it is importantfor our econom to have the most able

people in the right jobs.

In the UK over the last 30 ears,despite political attention on equalitof opportunit, we have seen socialmobilit decline.71 Both intra andintergenerational mobilit appear to beaffected b inequalit. Intergenerationalmobilit has been declining in Britainover the same period as the gap betweenthe top and the bottom has widened.72Further countries with higher levels ofinequalit also have lower levels of socialmobilit.73

As the World Bank argued in its World

Development Report 2006, poor socialmobilit will thus be harmful to long-run economic growth, leading the Bankto advise that in the long run, equit[of opportunity] and efciency may be

complements, not substitutes.74

bOX 4A BRIEF HIsTORy OF PAy IN FINANCE

Up until the 1930s and after the 1980s jobs in nancial intermediation

were relativel skill intensive, complex and highl paid, but this wasnotabl not the case in the interim period.69

From 1909 to 1933 the nancial sector was a high wage industry. During

the 1930s a dramatic shift occurred and the nancial sector lost much of

its wage premium relative to the rest of the econom. This dramatic dropwas followed b a more moderate decline from 1950 to 1980. Indeed bthe 1980s wages in the nancial sector were similar, on average, to wages

in the rest of the econom.

However, during the stock market big bang in the 1980s there was arapid shift and the nancial sector became once again a high skill, high

wage industry. It is notable that relative wages in nance had returned to

the levels of the 1930s b 2006.70

68 W. Hutton (2010)Hutton Review of FairPa in the Public Sector:interim report.69 T Philippon and A.Reshef (2008) Wagesand Human Capital in theU.S. Financial Industr:19092006.70 Ibid.71 J. Bladen (2005)Social mobilit inBritain: low and falling,CentrePiece, spring,http://cep.lse.ac.uk/centrepiece/v10i1/blanden.pdf; J. Blandenet al. (2001) Changes inintergenerational mobilitin Britain, CMPO workingpaper, www.bristol.ac.uk/cmpo/research/families/socialmobilit.

html; HM Government(2010) Opening Doors,Breaking Barriers: astrateg for social mobilit(2010) http://download.cabinetofce.gov.uk/social-mobilit/opening-doors-breaking-barriers.pdf.72 J. Bladen, P. Greggand S. Machin (2005)IntergenerationalMobilit in Europe andNorth America, LondonCentre for EconomicPerformance, LondonSchool of Economics.73 Wilkinson and Pickett,The Spirit Level.74 World Bank (2006)World DevelopmentReport 2006: equit and

development, OxfordUniversit Press; K. M.Murph, A. Shleifer andR. W. Vishn (1991)The allocation of talent:implications for growth,Quarterl Journal ofEconomics 106(2).


19/38


36

ATTITUDEs TO HIGH PAy

See Anne

It is also no surprise that economicpower tends to beget political power.In developed democratic nations likethe UK, this tends to work throughcontributions to political parties andaccess to politicians that wealth andmone can bu. This power can inturn be used to exert bias that favoursunreasonabl or unfairl the status quo or vested interests.82

This in turn creates backlashes in publicattitudes, which Prime Minister DavidCameron identied:

Fair pa in companies does not takeplace in isolation. Paing fair at the

top is not just about what is good forcompanies; it is also about ensuring thatthe very people who can benet the most

are not able to exert excessive inuence

in their own interest.

I believe that secret corporate lobbying, like the expenses scandal,

goes to the heart of why people are so fed up with politics. Itarouses peoples worst fears and suspicions about how our political

system works, with money buying power, power shing for money

and a cosy club at the top making decisions in their own interest.

We cant go on like this. I believe its time we shone the light of

transparency on lobbying in our country and forced our politics to

come clean about who is buying power and inuence.83

80 Vince Cable (2010)speech made at LiberalDemocrat Conference 2010.81 R. Williams and L. Elliott(2010) Crisis and Recover:ethics, economics and justice,Palgrave Macmillan, 21.82 D. Acemoglu (2011)Economic power begetspolitical power, TheEconomist, www.economist.com/economics/b-invitation/guest-contributions/economic_power_begets_political_power.83 D. Cameron (2010)Rebuilding trust inpolitics, speech, www.conservatives.com/News/Speeches/2010/02/David_Cameron_Rebuilding_trust_in_politics.aspx/

55%agree/agree

strongly

How much do you agree or disagree that

ordinary working people do not get their fair

share of the nation's wealth.

How much do you agree or d

the responsibility of the gove

the differences in income be

high incomes and those with


management will always try to get the better of

employees if it gets the chance.


big business benefits owners

of workers.


Differences in income in Britain are too large.


ordinary working people do n

share of the nation's wealth.

57%agree/agree

strongly

53%agree/agree

strongly

73%agree/agree

strongly

60%

agree/agree

strongly

8%disagree/disagree

strongly

14%disagree/disagree

strongly

59%agree/agree

strongly


strongly


strongly


strongly


strongly


20/38


38

However, through this investigation intohigh pa it has become evidentl clearthat the starting point should be basedon the ke principles of transparenc,accountabilit and fairness.

These ke principles, which areinterlinked and inseparable, have eachbeen missing, undermined or ignored fortoo long when it comes to pa at the top.yet ke reforms to the wa companiesbehave and are regulated could mark animportant turning point.

In the following section we put forwardwh these ke principles are important,and wh and how the are currentl

missing, and propose reforms that wouldbegin to redress this.

However, we must also recognise thatthere is no quick x. It took 30 years to

get us to this place and it ma easil takethat long to reverse. This is not to admitdefeat, but is a recognition that these arejust the rst steps in what is the much

longer and deeper process of cultural andeconomic change that is required.

In recognising this, the Commission hassought to put forward policies that canrepresent these rst important steps,

focusing on returning the three ke

principles to pa setting which have beenmissing for too long at the top. Theseprinciples relate to pa but the are partof a wider debate about not just what fairpa is, but what is pa in the context ofthe good econom?

3.1 Transparency

Sunshine is the best disinfecDavid

A growing focus over the last decadeon povert and pa at the bottomof the income spectrum, includingthe establishment of the Low PaCommission, has increased publicawareness and ensured we know moreabout what has happened to those atthe bottom but what has taken placeat the top of the income distribution hasremained largel a mster.

The original remit of the High PaCommission was to nd out what had

happened to pa at the top of theincome spectrum, and we have beendeepl concerned at the lack of availableinformation.

Further the Commission is concernedat the level of public understanding onwhat has happened at the top of the padistribution. Most people think that thepublic sector is better rewarded thanthe private sector and the people whoknow how well rewarded those at the topof our companies are, are few and farbetween.84 This further contributes to aculture of mistrust and public outragewhen the truth becomes apparent as it

invariabl seems to.

The government has identied the

importance of transparenc for restoringtrust in government and the public sector.It is right to recognise that transparenc

3|How do we

reform payat the top?

As this report has shown, there has beena dramatic escalation in top pa overthe last 30 ears. This growth has takenplace primaril in the private sector; it isour business leaders and bankers who aretaking a bigger slice of the pie even asaverage wages across the private sectorhave stagnated.

We are now at a tipping point wherecompan reputations hang in the balanceand our econom will not be helped b

allowing this to persist. Where now? isperhaps the most important question forus all to address.

This seemingl simple question raises amriad of issues, problems and pitfalls.It forces us to address not just what istoo much but what is fair and in the longterm interests of our businesses and oursociet. One report, one commission forone ear cannot hope to resolve all ofthese. Ultimatel it must be a process,taking place over the longer term inwhich business, politicians and thepublic engage.

Where now?


21/38


40

Indeed not onl has the value of awardsincreased, but also the numbers ofdirectors receiving them. At the heightof the crisis in 2009 83% of directorsstill received their annual bonus; indeedthis increased in 2010 to 95%. It seemsbeond belief that 95% of all leadexecutives in the FTSE 350 performedso well the earned an annual bonus,particularl when we consider that acrossthe FTSE 350 performance indicatorsimproved onl marginall.88

Executive pa packets now include asignicant performance-related element:

the average top award that could beachieved under all share-based incentive

schemes in the FTSE 100 was 328% ofsalar in 2010.89 This performance partof the total award is made up of a numberof elements (see box 6) tied to individualpersonal targets and compan performance.

This has contributed to increasingcomplexit in pa packages. Indeed it hasnow resulted in a situation where onlrelativel few individuals with technicalinsight are able to understand what anexecutive is being paid indeed evenwhen attempts are made to calculatethe total pa package, these are oftenchallenged b the compan. Thusdespite legislation designed to increase

transparenc in relation to executive pa,the issue remains murk to sa the least.

WHy HAS PERFORMANCE-RELATEDPAy BEEN USED?

The current view on performance-relatedpa for executives can be traced backto 1979 with an incoming Conservativegovernment and a new attitude to toppa.90 The government believed UKbusinesses would be more successful infuture if quasi-entrepreneurial capitalists atthe top of companies were created, linkingpa to performance and ting the interestsof the executive to those of the shareholderto manage the principal or agent problem.

The aspired to create an entrepreneurialspirit in what was seen as the tired,bureaucratic compan man. The

government of the time cut top rates oftax and encouraged the use of share-based awards. Share options arrived asthe rst wave of innovation. This was

followed b share option grants, thenlong-term incentive plans, and morerecentl a plethora of phantom options,restricted stock awards and matchingshare awards. It is assumed that whatmotivates executives most is mone, andthat the interests of shareholders are bestserved b appealing to this.

From 1979 we began to witness anincrease in executive pa. B the earl1990s this had started to prompt

concern from politicians and the generalpublic in light of the growing economicturmoil. In this context and in responseto the corporate scandals of Poll Peckand BCCI the Conservative governmentof the time brought in Lord Cadbur to

is essential for public trust and indeed thesame can be true of the private sector with greater transparenc companies canbegin to encourage greater public trust.

When it comes to pa in the corporate world,transparenc has been undermined b the ever

increasing complexit in the rewards that havebeen constructed for top executives. Thislevel of complexit was introduced throughinnovation in top pa designed to bring theinterests of the executive in line with those ofthe shareholder.

However, the extent to which thishas been successful is contested andperformance-related pa has gone onto undermine transparenc as well asfunction as a major driver of the growthof executive pa.85

UNDERSTANDING PAy FORPERFORMANCE

It is commonl argued that variable paand bonuses can effectivel be usedto encourage individuals to behave incertain was. Across the private sectorwe have seen a boom in performance-related pa, and indeed this principleis now being encouraged in the public

sector. The principle has been pushed toits extremes for those at the ver top ofthe pay spectrum in nance and other

companies, and is one of the ke driversof the escalation in top pa.

A focus on new and innovative formsof compensation, designed to aligninterests and link pa to performance,has accompanied an increase in theaggregate amount of the awards. Forexecutives this increase in performance-related pa has resulted in a dramaticescalation in the quantum received (seebox 5). Both the on-target and maximumlevels for performance-based rewards

have increased so that what passed asthe maximum bonus in 2002 is lowerthan what a director would receive todafor on-target performance.86

bOX 5EXECUTIvE PAy FOR PERFORMANCE87

Ke points include:

For on-target performance FTSE 100 lead

executives received a bonus worth 48% of salarat the median in 2002.

For the same level of performance in 2010, aFTSE 100 lead executive bonus was worth 90% ofsalar at the median.

In 2002, the median bonus for maximumperformance for a FTSE 100 lead executiveequalled 75% of salar.

B 2010, maximum performance for a FTSE 100lead executive commanded a bonus worth 150%of salar at the median.

Although less spectacular, similar increases inbonus thresholds took place for other FTSE 350directors.

In 2002, the median maximum grant of sharesthat a FTSE 100 lead executive could be awardedwas 100% of salar.

B 2010, the median maximum LTIP (LongTerm Incentive Plan) grant for a FTSE 100 leadexecutive had risen to 200% of salar.

85 For a discussion onwh pa for performancehas driven the growthin top pa see High PaCommission, More for

Less.86 Income Data Services(2011) What Are WePaing For? Exploringexecutive pa andperformance, High PaCommisison.87 Ibid.


22/38


42

bOX 6REMUNERATION FOR

EXECUTIvEs

The total remuneration for theexecutive includes:

base salar

benets

short-term incentives, such asannual bonuses

medium-term incentives, suchas deferred and matchingshares

long-term incentivesconsisting of performanceshares, share options or bothrunning concurrentl

a self or co-investment plan

a pension.

bOX 7THE PRINCIPAL AGENT PROBLEM

The principal agent problem occupies reams of academic texts, startingwith the work of Berle and Mears, Separation of ownership and control.96

Essentiall it is a recognition that the interests of the agents, the managersof companies, ma differ from the now diverse and disparate owners, theshareholders the principals.

What ma be in the managers interest, such as empire building or vanitprojects, ma not be in the interests of the shareholders. This is whcorporate governance and more recentl pa has been used as a method ofaligning the interests of the executive and the shareholders.

Aligning interests through pa is seen as the golden bullet of corporategovernance. In response, increasingl complex innovations in papractices have been used to attempt to align interests and motivate those

in companies to give the desired performance.

HAS PAy BEEN LINKED TOPERFORMANCE?

No reputable stud has shown thatexecutive pa has been successfulllinked to compan performance. Indeedthe bod of evidence challenging thelink between pa and performance hasbecome increasingl compelling.

This dislocation between pa andperformance has been most pronouncedin the last few ears of recessions wherea spectacular growth in bonus pamentsover the period has pulled signicantly

ahead of market capitalisation, earningsper share and pre-tax prot (see box 8).97

review corporate governance guidelines.His subsequent report published in 1992recognised the growth in executive pa andthe publics concern, and proposed greatershareholder oversight and an enlarged rolefor non-executive directors.91

In 1995 continuing public concern overexecutive pa focused particularl on thepa awards received b those at the top ofthe newl privatised utilities promptedthe government to bring in Sir RichardGreenbur of Marks & Spencer. Greenburaccepted and built on the principles laiddown b Cadbur and emphasised threeke themes that shaped future executivecompensation practice:

Link pa to performance.

Align interests of the executive andshareholders.

Increase shareholder oversight basedon increased disclosure on executive pa.

Despite this innovation in pa structuresand numerous attempts to link pa toperformance this ideal of creating quasi-entrepreneurs at the top of publicl listedcompanies has not been achieved for thefollowing reasons:

Unlike entrepreneurs, executiveshave no, or relativel little, directpersonal nancial investment in their

jobs. While the ma risk losing theirjob if the perform badl or there isa change in compan fortunes, aswith ever other emploee, unlike

the entrepreneur, ver little of theirpersonal capital is at risk if the fail.Even when the do lose their jobsthe often have generous severancepackages.92

The growth in performance-relatedpa has not come at the expenseof basic xed pay, which has also

increased. Over the last ten earsthere has been a 63.9% increase inexecutive base pa.93

According to a report conductedb Incomes Data Services for theHigh Pa Commission nearl all thecomponents of boardroom pa, withthe exception of share option gains,increased at a faster rate over the last

ten ears than corresponding measuresof corporate performance.94

Rather than link pa to performance,this has onl served to increase the totalamounts awarded. Between 1949 and1979 executive pa grew b 0.8% perear on average. Over the last 10 earsannual growth in the pa for FTSE 100executives has been closer to 20%.95

In essence, while entrepreneurs usuallrisk their own capital, boardroomexecutives, like bankers, risk otherpeoples. The granting of share optionsand long-term investment plans as a waof giving such executives skin in thegame has not reall delivered the levelsof entrepreneurial zeal the enthusiasts fortop pa ma have hoped for and expected.

91 Committee on theFinancial Aspects ofCorporate Governance(1992) Report with Codeof Best Practice, [CadburReport], Gee Publishing.92 High Pa Commission,More for Less.93 Executive pa based ongure from Income DataServices (IDS); averagepay based on gures fromthe Annual Surve ofHours and Earnings.94 Income Data Services,What Are We Paing For?95 C. Frdman and R.Saks (2007) Executive

compensation: a newview from a long-termperspective 1936-2005,http://papers.ssrn.com/sol3/papers.cfm?abstract_id=972399 ; High PaCommission (2011) MoreFor Less


23/38


24/38


46

The concerns over the attempts to linkexecutive pa to performance are onlexacerbated b the conceptualisation ofgood performance that is predominant.This is a view which sees long term aslimited to three ears and performanceas based solel on short-term shareholderreturns, rather than a broader conceptionof what is good performance basedon the extent to which the companprovides affordable and needed goodsand services, contributes to societ andacts to mitigate risk or environmentaldegradation.

The pa and performance obsessionhas not linked pa to performance

there is no evidence that despiteears of attempts it can be describedas successful but this experiment inexecutive pa has, however, increasedthe quantum. Attempts to link pato performance have served to makeexecutive pa increasingl complex andhard to understand. The have not onlincreased the total amount awarded,but have created an environment ofobfuscation and even deception.

Pa awards for those at the top of ourbiggest companies are too complicatedand this complication has not improvedperformance, but it has decreased

transparenc. In this environment it isalmost impossible to ascertain whathas happened to pa; for shareholdersand the general public, this damagesbusiness and public trust.

POLICy RECOMMENDATIONS

For the above reasons the Commissionmakes the following policrecommendations. While these policiesfocus on executive pa, it is should bestated that this principle should applacross the private sector.

simplif executie pa

As this report and others haveargued, pa packets for those atthe top of companies have becomeoverl complicated. Driven b so-called innovation in pa, each laer ofcomplication increases the quantum, and

et appears to have no positive impact oncompan performance.

Much of this innovation is exacerbatedb the role of remuneration consultantswho are brought in to design newer andmore sophisticated rewards, driven b adesire to link pa to performance. Thecomplication has knock on effects indamaging relations with shareholders,creating misconception, and encouragingconfusion and obfuscation.

Innovation in pa, like innovation innancial products, has gone too far,

which is wh we are calling for executive

pay to be returned to rst principles.Executives should like their workforce receive a basic salar. This should bedetermined b the reformed remunerationcommittee (see below). It is right thatcompanies determine the level of pa

bOX 9ATTITUDEs TO REWARDs BAsED ON INTERvIEWs CONDUCTED By THE HIGH PAy

COMMIssION

Ive had approaches from the US and if I wanted to maximise my earning potential, I should

have taken them, but theres more to life than money. This is my company and having a

chance to run it and bring it back to its best is a great privilege.

Andrew Witt, CEO GSK

Most people want to do something they are proud of; most people want to create a legacy and

leave something behind. There are also a set of broader needs: the younger generation want to

see the company is doing something different.

Ian Cheshire, CEO Kingsher

Im keen to create value for the pension funds that are our owners. I like bringing people on,

advancing careers. There are absolutely non-nancial reasons why people work, but you cant

ignore the nancial side.

A CEO of a UK compan

There are other motivations; its the chance to be associated with something important andnew and its about change management. I get a rush out of coming and changing something

for the better, it gives a value.

Tim OToole, CEO First Group

Indeed the view that executives can onlbe motivated b mone appears to be partof a strong anti-management sentimentthat is central to agenc theor.

While it is not clear whether pa has beenlinked to performance, it seems clear thatit is associated with other determiningfactors.104 One academic stud in

America found that pa increased basedon the number of social comparisonsavailable in a given geographical area ormembership group (for example golf clubor countr club). Average pa for chiefexecutives of S&P 500 companies with a

social circle of 82 other chief executives(the 75th percentile) was $560,000higher than for those with a social circleof just 15 chief executives (the 25thpercentile).105

Further research has also shown thatlarger executive networks are associatedwith poorer compan performance. This

certainl suggests that chief executivesare able to use their networks to increaserewards with little regard to compan orpersonal performance.106

104 High Pa Commission,More for Less.105 J. Ang, G. Nagel andJ. yang (2009) Theeffect of social pressureson CE

high pay commission final report

Documents