Investors focused on executive remuneration are looking to close the CEO-to-worker pay ratio.
While the responsibilities of a CEO or other c-suite executives – and the skills it takes to be a good one – do warrant a degree of incentivisation and reward, investors have long questioned and challenged pay packets that soar to dizzying heights.
“Historically, executive pay proposals have always been a hot topic at corporate annual general meetings (AGMs),” Michael Herskovich, Global Head of Stewardship at BNP Paribas Asset Management (BNPP AM), tells ESG Investor. The asset manager rejected 55% of resolutions relating to executive pay levels this past AGM season.
For all the misfortune and devastation it wrought, Covid-19 did bring about one positive change. Several CEO bonus pay packets were cut, in part as a response to investors’ expectation that a struggling global workforce be sufficiently supported during a challenging pandemic. This trend has unfortunately since seen a reversal.
The divide between CEO pay and the average annual earnings of employees stretches wide. In a time of rising inflation and a cost-of-living crisis, some investors have called for fair executive remuneration.
“Extreme pay inequalities are completely destabilising – it’s bad for democracy and it’s bad for capitalism,” says Rosanna Landis Weaver, Wage Justice and Executive Pay Programme Senior Manager at US shareholder advocacy non-profit As You Sow.
With a group of UK-based asset owners now consulting on a Fair Reward Framework (FRF), other investors choosing to hold corporate executives to account over the CEO-to-worker pay ratio, and the US President making history and joining a picket line, is now the time for change?
“We recognise that excellent CEOs who have the skills and acumen to deliver winning strategies are hugely important to economies and our portfolios,” says Clare Richards, Director of Social in the Church of England Pension Board’s (CoEPB) Responsible Investment Team.
“But equally, we join the dots. If how they are rewarded is completely out of sync with how the lowest paid in the company are treated, then they won’t be leading from the front and demonstrating that they value all parts of the business.”
Cap or no cap?
CEO-to-worker pay ratios are hugely varied. In 2020, FTSE 100 CEOs earned an average of 86 times more than the median full-time employee in the UK. In the US last year, S&P 500 CEOs earned 291 times more, with average annual earnings of US$15.3 million; research has highlighted that the average US CEO compensation has increased by 940% since 1978, yet only 12% for worker compensation.
But the ratio between workers and bosses can be even bigger than that, with research identifying pay ratios approaching 5,000:1 – a quite frankly mindboggling disparity.
“When you consider the fact that these pay ratios are usually based on the median employee, that means half of those employees are getting paid even less,” says Louis Ryall, Senior ESG Analyst at UK pension scheme Nest.
On the flip side, this also insinuates there are corporate executives being paid even more.
One solution would be for governments and regulators to introduce a cap on executive remuneration. But this wouldn’t be so simple in practice.
For starters, how should the pay ratio even be calculated, Herskovich asks. As an example, he questions whether a multinational company must draw up ratios for each jurisdiction it operates in, or whether it would be better to determine a worldwide average.
“It also depends on the sector,” he adds, noting that the pay ratio is likely to be much bigger for a company in the distribution sector – where a vast majority of employees may be on minimum wage – compared to financial services, meaning that an investor’s cross-sectoral comparison would need to account for that context.
Another option is to promote transparency so that investors have visibility of an investee company’s difference in pay between executives and the workforce, which will then hopefully inspire effective engagement on the topic.
In 2019, the UK introduced new rules which require listed companies with over 250 employees to publicly disclose their pay ratios, justify their executive remuneration, and how those bonuses account for wider employee pay.
Oil and gas major Shell, for example, reported an 80:1 median pay ratio for 2022.
With pay ratios in the listed domain – where companies may be paying very low wages while paying their CEOs a lot of money – public perception can pose “quite a significant reputational risk”, says Nest’s Ryall.
He adds that the pay ratio highlights how issues of fair worker pay and rights and fair executive remuneration are invariably connected.
Challenging companies on the value of one in their pay ratio, then, could serve as an effective way of preventing an over-inflation of executive bonus pay packets, experts speaking to ESG Investor determine.
“We’re going to reach a point where, if companies don’t have minimum thresholds in place for workers’ pay, then investors simply won’t support them on the executive pay side,” says Tom Powdrill, Head of Stewardship at the Pensions and Investment Research Consultants (PIRC).
Some asset owners and managers – like Nest and BNPP AM – indicated in their 2023 global voting guidelines that they may vote against companies on their executive remuneration packages if these are not aligned with their average growth of worker pay.
Connections have been drawn between labour unions and CEO pay, with research showing that companies with strong unions typically pay their CEOs less, partly thanks to workers having a stronger bargaining position.
Yet the wider question of fair executive remuneration remains, with experts noting that standardisation is likely some way off.
“Ultimately, fair executive remuneration should involve modest salary equity, a much longer holding period, clear disclosure, and less complexity,” according to As You Sow’s Landis Weaver.
Severine Neervoort, Global Policy Director at the International Corporate Governance Network (ICGN), agrees that fair executive remuneration should be “reasonable and equitable”, with company boards considering their overall human capital management strategy when setting executive remuneration levels.
She says that ICGN’s Global Governance Principles recommend that corporate boards are “mindful of societal concerns, such as the cost-of-living crisis and income inequality”.
“[Boards] need to take into consideration the level of pay of the average company worker and the average median income of the company’s place of domicile,” Neervoort notes.
Increasingly, investors are determining that fair executive remuneration should also include the integration of ESG-related KPIs within pay structures, although this, too, presents a series of challenges.
Neervoort says that ESG metrics should be quantifiable indicators that are material to the company’s sustainable value creation and anchored in the business strategy.
Oscar Warwick Thompson, Head of Policy and Communications at the UK Sustainable Investment and Finance Association (UKSIF), tells ESG Investor that tying ESG to executives’ financial incentives must be done carefully “to avoid a common trend of higher remuneration across the board”.
“There is some academic evidence highlighting risks of further inflated executive pay in some instances where executive pay and incentive plans have been linked to sustainability goals and ESG-related KPIs,” he says.
In April, PIRC published a report assessing global listed companies’ inclusion of climate-related metrics within their executive remuneration schemes. It warned there is a “fundamental disconnect” between performance and pay outcomes, with assessed companies enjoying an average vesting level of 80%, yet most targets proved not easily measurable or sensitive to the decision-making of executives.
“There are far clearer criteria around tying greenhouse gas emissions (GHG) [reductions] and other climate metrics to pay incentives, but the same cannot be said for the social dimension of ESG,” adds BNPP AM’s Herskovich.
The issues surrounding procuring, disclosing and scrutinising corporates’ social-related data are well-documented. It stands to reason that being able to effectively track and ultimately achieve a social-focused KPI, then, is far more difficult.
Despite challenges, UK asset owners are currently consulting on the FRF in the hope of better defining exactly what they want to see from investee companies on executive pay.
Open to feedback until late October, the FRF seeks to provide more clarity on how reward is divided between a broad range of corporate stakeholders, according to Richards from CoEPB, one of the asset owners leading the initiative. The framework will gather a broad range of relevant data points in one place, so investors can pick up that information and use it to engage meaningfully with companies on their approach to pay, she says.
The draft framework is divided into three main sections: company characteristics, pay scrutiny process, and reward outcomes.
“Ultimately, we want to draw attention to good practice within the corporate world and encourage laggards to raise their game, as inconsistency in boosting the wealth of the c-suite while neglecting to fairly reward the shopfloor contributes to a systemic risk that we cannot ignore,” Richards says.
She notes that it is of “paramount importance” that companies ensure that their executive remuneration awards “are the same as would be attractive to any other worker”, such as a decent level of baseline pay, employer pension contributions, and long-term incentives.
“As asset owners, we are concerned when we see huge disparities in the level of reward that is applied at a senior level while, for instance, the company fails to commit to paying a real living wage or doesn’t disclose on its ethnicity pay ratio, or demonstrate what actions it is taking to address gender pay gaps.
“These are areas that are hugely material for our pension beneficiaries, because it is society that picks up the tab when companies constrain reward at the lower-end of the pay scale: for instance, through the need for in-work social support benefits or the effect that being on an unwelcome financial rollercoaster between pay days has in terms of a corrosive impact on mental health and relationships,” Richards says.
The asset owner group, which also includes Brunel Pension Partnership, Nest and Railpen, has been supported by formerly independent consultant Deborah Gilshan (now Head of ESG and Stewardship at AustralianSuper) and Luke Hildyard of the High Pay Centre.
“We [CoEPB] will be drilling down into this information [from the framework] to draw our own conclusions on whether pay policies and pay awards that are on AGM ballots are based on sound foundations, and we will be pre-declaring our votes to help inform the considerations of other investors,” says Richards.
Change from the bottom
Not everyone in the investment industry believes that current executive remuneration levels are unfair.
“The reality is that there are still some [in the finance sector] who think that, actually, corporate executives aren’t paid highly enough,” says PIRC’s Powdrill.
In May, London Stock Exchange CEO Julia Hoggett claimed UK firms need to ensure even higher pay for their executives in order to retain listings, secure coveted executive-level talent, and maintain the attractiveness of London’s capital markets.
“When thinking about fairness in this area, investors need to think about whether they mean fairness in terms of executive pay, or fairness in terms of the level of work or pay for the workforce,” Powdrill says.
“Should investors look to restrain pay at the top or build up pay from the bottom?”
Powdrill thinks the latter, while “holding constant at the top”, may ultimately be a more effective strategy for investors to introduce fairness to the CEO-to-worker pay ratio.