By Iain Stark, International HR leader and reward expert

What is the “fair” level of CEO pay?  Into this debate comes the CEO pay ratio, especially since the crisis in 2008. 

While many consider this metric a flawed and simplistic distraction from the real issues, others cite it is an element for transparency, shareholder engagement and focus on longer-term pay for performance.  There is momentum in many countries with public and political attention or even legislation.  It is an opportunity for companies to communicate more how they pay beyond the senior team, and a logical extension is inclusion as part of the growing investor focus on Environmental, Social and Governance (ESG) ratings and Corporate Social Responsibility (CSR).   This article takes examples from across the world to consider lessons and how businesses can think ahead on an issue that is building.

The headlines?  No better example than “Fat Cat Friday” in the United Kingdom in January this year.  Across the FTSE 100 the average ratio was 133x, ie, the CEO was paid in less than 3 days what their median employee was paid for the year.

Does this matter for business results? The management guru Peter Drucker suggested that the ratio should not be more than 20x-25x as beyond it is difficult to foster the kind of teamwork and trust that businesses need to succeed.  It was around 20x when he wrote this, in the US.  Today the ratio is at 100x+ in many successful businesses and has been for years at the same time as employee engagement is called out as a key for success.

The following examples from the US, the UK, the Netherlands, France and the European Union (summary table here), where there are recent or pending regulations/codes, Australia which may follow, and then Switzerland, India and Norway. While companies and their executive committees naturally focus on their home country it pays to be aware of what is happening in the rest of the world which may “spillover” to that country.

First, in the United States reporting started in 2018 following the Dodd-Frank Act that passed in 2010. The delay?  There was much debate, perhaps not surprising, as the US Congress had not expressly stated the exact purpose or intended benefits of including the ratio in the Act.  And some are still pushing to remove this.

The first results generated headlines such as “Among 100 chiefs analysed, 11 made more than 1,000 times that of the median employee”, although there was as much interest in the which sectors and employers paid most to their median employee.  As the second wave of results come around, headlines continue, ie, this recent New York Times article. 

Shareholders and their advisors (ISS/Glass Lewis/etc.) have so far paid limited attention to the ratio in “say on pay” votes, among the reasons being:

• there is no correlation with performance, ie, Total Shareholder Return;
• it is a short-term metric that is not useful in assessing longer-term results and the potential value to all shareholders is not taken into account (perhaps the most extreme example being 40,668x for Elon Musk at Tesla after a very special option award valued at $2.3 billion based on market capitalisation, revenue and profit growth hurdles; it was 1x for actual compensation of $56K);

and

• the comparison is with all employees worldwide across very different pay markets, although companies can choose to add separate US and non-US ratios.

2 counter-arguments are :

1. If the ratio is simplistic because executive pay contains complex multi-year risk:reward designs, this is exactly the sort of “simple” transparency the ratio is aiming to flush out that can then inform pay decisions.
2. At the very least the results set a baseline to compare the trend versus a median that should be relatively stable unless the underlying business changes significantly (companies can use the same median for 3 years) and with business performance. Disclosure of this trend is where the European Union Shareholder Rights Directive landed and the trend is also in the new legislation France (more on that below).

In the United Kingdom, new executive pay transparency measures came into force on January 1, 2019 to update disclosures, requiring publication of the ratio versus the 25^th, median and 75^th percentile of UK employees as part of wider measures such as setting out how employee and other stakeholder interests are taken into account and the impact of share price growth on executive pay.  

In the Netherlands, the corporate governance code encourages but does not require disclosure.  The code allows companies to select a representative reference group and the pay used, ie, Airbus, a French CAC 40 company registered in the Netherlands used cash compensation for full-time employees in France, Germany, Spain and the UK. 

The law in France to support business growth and transformation (la loi PACTE) which was approved this month includes a requirement to disclose the pay of the most senior executives versus the average and the median employee, and then the trend over 5 years.

The European Union’s Shareholder Rights Directive (Company , which member states are to bring into force by June 10 this year, comes at the issue in a less direct way.  The Directive starts with the 2008 crisis and concerns about short-termism, and has as a key objective to “encourage long-term shareholder engagement and to enhance transparency between companies and investors”. It does not require pay ratio disclosures, but instead the annual change in directors’ remuneration (not just the CEO), of the performance of the company, and of average remuneration of employees, with the trend over at least 5 years to be published.  Countries have significant flexibility in how they adopt the directive, but the objective and principles are clear.  As in the US, it will at least set a baseline.

Australia may be one of the next countries to require disclosure, with the US and UK being cited as role models, the driving concern again being that workers have been left behind.  Requirements were not expected before 2021 and the surprise re-election of the centre-right coalition may have put this further on hold.

Switzerland, India and Norway (table below), where there are no ratio disclosure requirements today, offer examples of where the ratio may a) impact change overall (Switzerland), b) increase transparency (India) and d) reinforce culture (Norway). 

Next?

So far disclosure of the ratio has probably added as much heat as light to the executive pay debate. But it has forced some important discussion. If an objective is to help shareholders decide what makes sense, then it is a baseline for the future and a further prompt to look at the whole package including special payments. If an objective is greater transparency and consideration of what is fair in society then the headlines are impacting the debate in many countries.   Companies and their executive committees should be sensitive to this public scrutiny and take the opportunity to communicate to all stakeholders about why the ratio in their business is the right ratio and fair in the context of how all employees are paid.