It would be instructive to have CEOs explain exactly why they are worth so much more
Recent research for the High Pay Centre estimated that the average FTSE 100 CEO was paid roughly 150 times their average employee – with some CEOs paid up to 1,000 times as much. The US announced last month that American companies will be forced to publish the pay ratio between their lead executive and their median employee. Will the UK follow suit?
First, let’s look at the obvious question: why do some people earn so much? Are the chief executives of banks and FTSE 100 companies worth hundreds of times more than their average or lowest paid employee? Or than me? Of course not, and the multiples can and should be reduced. It is instructive to look at the income distribution for the UK (and the pattern is similar for other OECD countries).
Would you say that a couple who are both teachers on average pay for their profession of about £30,000 a year, with two teenage children at home, and paying an average council tax bill and mortgage, are rich? Probably not.
Yet they are: they have a higher income than 82 per cent of the population. The person half way along the UK income distribution earned just over £21,000 last year.
The income distribution is not symmetric; the top tail of the distribution is very far away indeed from the main bulk. Few people appreciate just how distant the top earners are from everyday experience. Economic forces are part of the explanation for soaring top pay since the 1990s, but they are not as inexorable as the forces of physics, nor are they the whole story.
And the chasm between top and ordinary pay has damaging consequences, political as well aseconomic. The gap in resources, opportunities and experience between the 1 per cent and 99 per cent is steadily undermining democracy; there is no way in which we are ‘all in this together’.
The economic triggers for increased income inequality – which has occurred in all the developed economies including Scandinavia – were new technologies and globalisation. The digital technologies have spread ‘winner take all’ or ‘superstar‘ effects. Just as the most popular movie stars earn vastly more than actors who are almost as good, the wide reach of online and increasingly global markets means the top earners in many professions have pulled far ahead of the pack. The technologies have generally increased the pay for people with certain kinds of skills, reflected in the increased wage premium for people with degrees.
While the top of the distribution was being stretched upward, the process of deindustrialisation, and the loss of well-paid jobs for large numbers of people (mainly men) in manufacturing, has pushed many people towards the bottom of the income distribution. The phenomenon of ‘hollowing out’ of the middle earners is universal. However, the global and technological forces are not the end of the story. High earners have also cemented and enhanced their advantage by progressively rigging the institutions of the market in their favour.
The most glaring examples occur in finance, where the deregulation of speculative trading activities and the bonus culture have vastly enriched a small number of people, while the costs of their risk-taking have been borne by the majority. Corporate executives elsewhere have steadily adopted the same practices, including remuneration committees that ratchet up pay by all wanting their executives to be in the top quartile, and that pay asymmetric bonuses (how many top earners have repaid money to their company when profits decline?)
The claim that pay needs to be performance related is distorted by defining performance in terms of share price over short periods, rather than, say, customer satisfaction over 10 years.
The whole of the corporate sector has been financialised and has drifted away from its fundamental purpose of investing in goods and services that will serve customers and society. Some of the measures needed will be long term remedies. A total rethink of education is one of them: what do schools need to do to enable young people to work alongside new technologies and share in the economic benefits of advancing technology and productivity? The answer will not be testing their powers of memory to turn them into more expensive and less effective versions of computers.
However, the institutions of the market can be addressed on a far faster timescale. Corporate law and governance codes can go along way to tackle the excesses of top pay. Companies could be required to publish pay multiples and also to set out a policy on their internal distribution of pay. What top to bottom or top to median pay multiple will help achieve the company’s strategic objectives? It would be instructive to see executives being required to explain in detail, with reference to specific metrics, why they are worth 400 times more than their employees.
Remuneration committees could be required to stop using relative measures to set ‘reward’, ending the upward ratchet, and to disregard share price – so easily manipulated by executives – as a measure of value. Tax and pension legislation can be used to discourage the ‘variable’ pay, the share option and bonus schemes, typically used to inflate top pay.
In his famous book, Capitalism and Freedom, the ur-free market economist Milton Friedman argued in favour of an unequal distribution of incomes. He said different levels of pay were needed to induce people to invest years in training, or to reward those who took risky career decisions like becoming an actor or footballer or author.
Some people work harder than others. Sometimes too people are lucky, and we do not begrudge someone who wins the lottery. Finally, he said inequality is needed to build up the savings that finance the investment needed for future progress. But he also argued that governments should be careful not to allow some groups of people to build up market power that would enable them to extract unfair incomes.
And, he wrote that the results of the market were ‘unlikely to be tolerated unless it is also regarded as yielding distributive justice’. The financiers and executives who are lucky enough to have that kind of market power – far beyond what Friedman could have imagined possible when he wrote in 1961 – are distorting the economy and destroying democratic consensus.
Narrowing the pay gap would increase investment (no more incentive to keep up the share price by buyback schemes instead of investing in the company), improve productivity (through higher investment and greater enthusiasm among the rest of the workforce), and above all repair the catastrophic loss of trust in corporate elites that is destroying the market economy and liberal democracy.
Diane Coyle is a Professor of Economics at the University of Manchester. This is part of a new collection of essays published by the High Pay Centre
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