The median pay of chief executives of the FTSE 100 companies rose 11% in 2017 to £3.93 million per year, according to figures released by the High Pay Centre. By contrast, the median pay of full-time workers rose by just 2%. Given two huge pay increases for the CEOs of Persimmon and Melrose Industries of £47.1 million and £42.8 million respectively, the mean CEO pay rose even more – by 23%, from £4.58 million in 2016 to £5.66 million in 2017. This brings the ratio of the mean pay of FTSE 100 CEOs to that of their employees to 145:1. In 2000, the ratio was around 45:1.
These huge pay increases are despite criticisms from shareholders and the government over excessive boardroom pay awards and the desire for more transparency. In fact, under new legislation, companies with more than 250 employees must publish the ratio of the CEO’s total remuneration to the full-time equivalent pay of their UK employees on the 25th, 50th (median) and 75th percentiles. The annual figures will be for pay starting from the financial year beginning in 2019, which for most companies would mean the year from April 2019 to April 2020. Such a system has been introduced in the USA this year.
So why has the gap in pay widened so much? One reason is that there is no formal mechanism whereby workers can apply downward pressure on such awards. Although Theresa May, in her campaign to become Prime Minister in 2016, promised to put workers on company boards, the government has since abandoned the idea.
Executive pay is awarded by remuneration committees. Membership of such committees consists of independent non-executive directors, but their degree of independence has frequently been called into question and there has been much criticism of such committees being influenced by their highest paying competitors or peers. This has had the effect of ratcheting up executive pay.
Then there is the question of the non-salary element in executive pay. The incentive and bonus payments are often linked to the short-term performance of the company, as reflected in, for example, the company’s share price. In a period when share prices in general rise rapidly – as we have seen over the past two years – executive pay tends to rise rapidly too. A frequent criticism of large UK businesses is that they have been too short-termist. What is more, bonuses are often paid despite poor performance.
There has been some move in recent years to make incentive pay linked more to long-term performance, but this has still led to many CEOs getting large pay increases despite lack-lustre long-term performance.
Then there is the question of shareholders and their influence on executive pay. Despite protests by many smaller shareholders, a large proportion of shares are owned by investment funds and their managers are often only too happy to vote through large executive pay increases at shareholder meetings.
So, while the pressures for containing the rise in executive pay remain small, the pay gap is likely to continue to widen. This raises the whole question of a society becoming increasingly divided between the few at the top and a large number of people ‘just getting by’ – or not even that. Will this make society even more fractured and ill at ease with itself?
Articles
Information and data
Questions
- How would you set about establishing whether CEOs’ pay is related to their marginal revenue product?
- To what extent is executive pay a reflection of oligopolistic/oligopsonistic behaviour?
- In what ways can game theory shed light on the process of setting the remuneration packages of CEOs? Is there a Nash equilibrium?
- What are the advantages and disadvantages of linking senior executives’ remuneration to (a) short-term company performance; (b) long-term company performance?
- What is/are the best indicator(s) of long-term company performance for determining the worth of senior executives?
- Consider the arguments for and against capping the ratio of CEOs’ remuneration to a particular ratio of either the mean or median pay of employees. What particular ratio might be worth considering for such a cap?
In the following article, Joseph Stiglitz argues that power rather than competition is a better starting point for analysing the working of capitalism. People’s rewards depend less on their marginal product than on their power over labour or capital (or lack of it).
As inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works.
Thus the huge bonuses, often of millions of pounds per year, paid to many CEOs and other senior executives, are more a reflection of their power to set their bonuses, rather than of their contribution to their firms’ profitability. And these excessive rewards are not competed away.
Stiglitz examines how changes in technology and economic structure have led to the increase in power. Firms are more able to erect barriers to entry; network economies give advantages to incumbents; many firms, such as banks, are able to lobby governments to protect their market position; and many governments allow powerful vested interests to remain unchecked in the mistaken belief that market forces will provide the brakes on the accumulation and abuse of power. Monopoly profits persist and there is too little competition to erode them. Inequality deepens.
According to Stiglitz, the rationale for laissez-faire disappears if markets are based on entrenched power and exploitation.
Article
Monopoly’s New Era Chazen Global Insights, Columbia Business School, Joseph Stiglitz (13/5/16)
Questions
- What are the barriers to entry that allow rewards for senior executives to grow more rapidly than median wages?
- What part have changes in technology played in the increase in inequality?
- How are the rewards to senior executives determined?
- Provide a critique of Stiglitz’ analysis from the perspective of a proponent of laissez-faire.
- If Stiglitz analysis is correct, what policy implications follow from it?
- How might markets which are currently dominated by big business be made more competitive?
- T0 what extent have the developments outlined by Stiglitz been helped or hindered by globalisation?
As part of the Basel III round of banking regulations, representatives of the EU Parliament and member governments have agreed with the European Commission that bankers’ bonuses should be capped. The proposal is to cap them at 100% of annual salary, or 200% with the agreement of shareholders. The full Parliament will vote in May and then it will go to officials from the 27 Member States. Under a system of qualified majority voting, it is expected to be accepted, despite UK resistance.
The main arguments in favour of a cap are that it will reduce the focus of bankers on short-term gains and reduce the incentive to take excessive risks. It will also appease the anger of electorates throughout the EU over bankers getting huge bonuses, especially in the light of the recession, caused in major part by the excesses of bankers.
The main argument against is that it will drive talented top bankers to countries outside the EU. This is a particular worry of the UK government, fearful of the effect on the City of London. There is also the criticism that it will simply drive banks into increasing basic salaries of senior executives to compensate for lower bonuses.
But it is not just the EU considering curbing bankers’ pay. The Swiss have just voted in a referendum to give shareholders the right to veto salaries and bonuses of executives of major companies. Many of these companies are banks or other financial sector organisations.
So just what will be the effect on incentives, banks’ performance and the movement of top bankers to countries without such caps? The following videos and articles explore these issues. As you will see, the topic is highly controversial and politically charged.
Meanwhile, HSBC has revealed its 2012 results. It paid out $1.9bn in fines for money laundering and set aside a further $2.3bn for mis-selling financial products in the UK. But its underlying profits were up 18%. Bonuses were up too. The 16 top executives received an average of $4.9m each. The Chief Executive, Stuart Gulliver, received $14.1m in 2012, 33% up on 2011 (see final article below).
Webcasts and podcasts
EU moves to cap bankers bonuses Euronews on Yahoo News (1/3/13)
EU to Curb Bank Bonuses WSJ Live (28/2/13)
Inside Story – Curbing Europe’s bank bonuses AlJazeera on YouTube (1/3/13)
Will EU bonus cap ‘damage economy’? BBC Radio 4 Today Programme (28/2/13)
Swiss back curbs on executive pay in referendum BBC News (3/3/13)
Has the HSBC scandal impacted on business? BBC News, Jeremy Howell (4/3/13)
Articles
Bonuses: the essential guide The Guardian, Simon Bowers, Jill Treanor, Fiona Walsh, Julia Finch, Patrick Collinson and Ian Traynor (28/2/13)
Q&A: EU banker bonus cap plan BBC News (28/2/13)
Outcry, and a Little Cunning, From Euro Bankers The New York Times, Landon Thomas Jr. (28/2/13)
Bank bonuses may shrink – but watch as the salaries rise The Observer, Rob Taylor (3/3/13)
Don’t cap bank bonuses, scrap them The Guardian, Deborah Hargreaves (28/2/13)
Capping banker bonuses simply avoids facing real bank problems The Telegraph, Mats Persson (2/3/13)
Pro bonus The Economist, Schumpeter column (28/2/13)
‘The most deluded measure to come from Europe since fixing the price of groceries in the Roman Empire’: Boris Johnson attacks EU banker bonus cap Independent, Gavin Cordon , Geoff Meade (28/2/13)
EU agrees to cap bankers’ bonuses BBC News (28/2/13)
Viewpoints: EU banker bonus cap BBC News (28/2/13)
Voters crack down on corporate pay packages swissinfo.ch , Urs Geiser (3/3/13)
Swiss voters seen backing executive pay curbs Reuters, Emma Thomasson (3/3/13)
Swiss referendum backs executive pay curbs BBC News (3/3/13)
Voters in Swiss referendum back curbs on executives’ pay and bonuses The Guardian, Kim Willsher and Phillip Inman (3/3/13)
Swiss vote for corporate pay curbs Financial Times, James Shotter and Alex Barker (3/3/13)
HSBC pays $4.2bn for fines and mis-selling in 2012 BBC News (4/3/13)
Questions
- How does competition, or a lack of it, in the banking industry affect senior bankers’ remuneration?
- What incentives are created by the bonus structure as it is now? Do these incentives result in desirable outcomes?
- How would you redesign the bonus system so that the incentives resulted in beneficial outcomes?
- If bonuses are capped as proposed by the EU, how would you assess the balance of advantages and disadvantages? What additional information would you need to know to make such an assessment?
- How has the relationship between banks and central banks over the past few years created a moral hazard? How could such a moral hazard be eliminated?
Two reports released by Incomes Data Services tell dramatically contrasting stories about pay in the UK. One report focuses on average pay in the public and private sectors, which are both likely to fall in real terms in 2011. Most public-sector workers will see a freeze in their wages and, whilst private-sector workers’ pay could rise by an average of 3%, this will still be below the rate of inflation. The press release Pay awards may rise but will trail inflation (6/1/11) to the report stated that:
Private sector pay settlements in 2011 could well be higher than in 2010, as long as the economic recovery remains on track. But following the latest increase in VAT, they are likely to trail inflation, meaning that the cost of living may be set to rise faster than average pay settlements for the second year running.
However, the press release to an earlier report, FTSE-100 bosses see earnings rise 55% (29/10/10), stated that:
FTSE-100 directors saw their total earnings boosted by an average of 55% while across the FTSE 350 as a whole total board pay went up by an average 45%, according to the latest Directors Pay Report, published by Incomes Data Services. (Year to June 2010)
On the back of these increases FTSE 100 chief executives took home £4.9 million on average in total earnings during the year.
Meanwhile, there is continuing public outcry over the levels of bank pay and bonuses. Despite billions of pounds of public money having been poured into banks to prevent their collapse, bank bosses are set to receive huge remuneration packages worth several million pounds in some cases. And, despite being condemned by the government, it seems there is little it can do to curb them.
So what are the causes of the growing income divide between those at the top and everyone else? And what are the economic consequences? The following articles explore the issues.
Articles: IDS reports
Year of pain predicted for workers.. while bosses’ salaries continue to grow Daily Record, Magnus Gardham (7/1/11)
Another 12 months of pay freeze misery for workers… but bosses enjoy a huge 55% salary increase Daily Mail, Becky Barrow (6/1/11)
Private-sector pay set to trail behind inflation People Management, Michelle Stevens (6/1/11)
Private pay deals to lag behind inflation Financial Times, Brian Groom (6/1/11)
UK boardroom pay rises 55% in an age of austerity Guardian, Simon Goodley and Graeme Wearden (29/10/10)
Private sector pay ‘to trail inflation’ in 2011 BBC News (6/1/11)
Staff morale warning over bosses’ pay rises Independent, Jon Smith (6/1/11)
‘Dose of reality’ call over top pay BBC Today Programme, Robert Peston, Brendan Barber and Garry Wilson (6/1/11)
‘Severe squeeze’ on average pay BBC Today Programme, Ken Mulkearn (Editor of the Incomes Data Services pay review) (6/1/11)
UK inflation rate rises to 3.7% BBC News , Ian Pollock (18/1/11)
Articles: bankers’ bonuses
Bank bonuses ‘to run to billions in 2011’ BBC News, (7/1/11)
Cameron says banks ‘should pay smaller bonuses’ BBC News, (9/1/11)
David Cameron warns RBS over bonuses Guardian, (9/1/11)
Banks say ‘no’ to bonus backdown Management Today, Andrew Saunders (7/1/11)
Banks to pay out billions in bonuses BBC News blogs: Peston’s Picks, Robert Peston (6/1/11)
Why government can’t stop big bonus payments BBC News blogs: Peston’s Picks, Robert Peston (7/1/11)
Diamond: ‘I am compelled to pay big bonuses’ BBC News blogs: Peston’s Picks, Robert Peston (11/1/11)
Data
Average Weekly Earnings Incomes Data Services
Questions
- Why are average earnings likely to be less than the rate of inflation in 2011?
- Why were the directors of the FTSE 100 companies paid an average 55% pay increase for the year to October 2010?
- To what extent can marginal productivity theory explain the huge increases of bosses of top companies?
- If remuneration committees base executive pay increases on the average of the top 25% of increases of equivalent people in other companies (to stop ‘poaching’), what will be the implications for executive pay rises over time?
- What market failures are there in determining executive pay?
- What will be the implications for staff morale if their earnings are falling in real terms while their bosses are receiving huge pay increases? Should these implications be taken into account when deciding executive remuneration packages?
- Are shareholders in FTSE 100 companies likely to welcome the pay increases of their top executives? If so, why? If not, why not?
We have covered the issue of bank bonuses in previous blogs. See for example: Banking on bonuses? Not for much longer (November 2009); “We want our money back and we’re going to get it” (President Obama) (January 2010); and Payback time (Updated April 2010). But the issue has not been resolved. Despite public outrage around the world over the behaviour of banks that caused the credit crunch and about banks having to be bailed out with ‘taxpayers money’ and, as a result, people facing tax rises and cuts in public-sector services and jobs, bankers’ pay and bonuses are soaring once more. The individuals who caused the global economic crisis seem immune to the effects of their actions. But are things about to change?
The Committee of European Banking Supervisors (CEBS) has confirmed tough new guidelines on bank bonuses applying to all banks operating in the EU. The CEBS’s prime purpose in recommending restricting bonuses is to reduce the incentive for excessive and dangerous risk taking. As it states in paragraph 1 of the Guidelines on Remuneration Policies and Practices:
Whilst institutions’ remuneration policies were not the direct cause of this crisis, their drawbacks, nonetheless, contributed to its gravity and scale. It was generally recognized that excessive remuneration in the financial sector fuelled a risk appetite that was disproportionate to the loss-absorption capacity of institutions and of the financial sector as a whole.
The guidelines include deferring 40–60% of bonuses for three to five years; paying a maximum of 50% of bonuses in cash (the remainder having to be in shares); setting a maximum bonus level as a percentage of an individual’s basic pay; appointing remuneration committees that are truly independent; publishing the pay and bonuses of all senior managers and ‘risk takers’. Although they are only recommendations, it is expected that bank regulators across the EU will implement them in full.
So will they be effective in curbing the pay and bonuses of top bank staff? Will they curb excessive risk taking? Or will banks simply find ways around the regulations? The following articles discuss these issues
Articles
Bankers’ bonuses to face strict limits in Europe BBC News, Hugh Pym (10/12/10)
Bankers’ bonuses to face strict limits in Europe BBC News (10/12/10)
Europe set to link banking bonuses to basic salaries The Telegraph, Louise Armitstead (10/12/10)
Some bankers may escape EU cash bonus limit moneycontrol.com (India) (11/12/10)
Banks to sidestep bonus crackdown by raising salaries Guardian, Jill Treanor (10/12/10)
Bonuses: When bank jobs pay Guardian (11/12/10)
Bank bonuses (portal page) Financial Times
Committee of European Banking Supervisors (CEBS)
CEBS home page
CEBS has today published its Guidelines on Remuneration Policies and Practices (CP42) CEBS news release (10/12/10)
Guidelines on Remuneration Policies and Practices (10/12/10)
Questions
- What are main objectives of the CEBS guidelines?
- Assess the arguments used by the banking industry in criticising the guidelines.
- In what ways can the banks get around these new regulations (assuming the guidelines are accepted by EU banking regulators)?
- What conditions would have to met for a remuneration committee to be truly independent?
- How likely is it that countries outside the EU will adopt similar regulations? How could they be persuaded to do so?
