UK: FAT IS A RELATIVE ISSUE. - As with mad cow disease, ignorance is the mother of hysteria. The executive pay picture is put into perspective by a look at the facts and at the influences that bear upon them.

by Derek Matthews.
Last Updated: 31 Aug 2010

As with mad cow disease, ignorance is the mother of hysteria. The executive pay picture is put into perspective by a look at the facts and at the influences that bear upon them.

It seems that the question of top management pay will not go away. Every week the so-called fat cats come in for a few more vicious kicks.

Indeed, the issue of executive rewards has developed into a corporate equivalent of mad cow disease - a combination of clumsy PR and government bungling leading to an outbreak of mass hysteria in which prejudice takes over entirely from dispassionate consideration of facts. No doubt malice and hypocrisy play their part too. But you only have to mention the subject, and otherwise sensible people who are by no means malicious or hypocritical immediately show symptoms of this human strain of BSE. 'Pure greed,' mouthed Will Hutton - best-selling analyst of our economic woes - of the 1994 pay increase awarded to Cedric Brown, then head of British Gas. Presumably Hutton set strict limits on the royalties he was prepared to accept for The State We Are In.

The continuing uproar over Brown's 75% pay rise probably cost the hapless chief executive his job 18 months later. But if so, ignorance, rather than spite, was mainly to blame. For some reason highly paid executives (Brown among them) have seemed quite incapable of defending or explaining themselves, while everyone else is content to pass judgments based to a large degree on ignorance. This does not exclude the Greenbury committee, which was charged with looking into the matter, or the Government which will apparently do more or less as it is told by such ad hoc committees.

It's significant that the Greenbury report, following the precedent set by Cadbury, contains not a single piece of data on directors' remuneration.

Nevertheless, Greenbury stated (presumably as 'a well known fact') that some water and energy companies paid their managers too much; and thereby stampeded the chancellor, Kenneth Clarke, into changing the tax treatment of share options. Clarke failed to appreciate that his actions would not increase the fat cats' tax bill, but would hit hundreds of thousands of relatively slim cats rather hard. As with mad cow disease, ignorance is the mother of hysteria. Rather than join in the 'yah boo' debate, it's time that everyone - managers in particular - looked at the facts behind executive pay, and at the influences that bear upon it.

There's no question that senior managerial salaries (leaving aside share options, but including all bonuses and benefits) have been growing rapidly in recent years. Average boardroom remuneration in the median FT-SE 100 company increased, after inflation, by an annual 8% in 1985-1994. Over the same period, and on the same basis, the rewards of the highest paid executive (HPE) rose by an average 12.1% annually - vastly greater than the rate of increase in the population as a whole.

The details are hardly difficult to come by. The past accounts of every public company reveal how much was earned by its directors year-by-year as far back as 1970, while the earnings of HPEs have been available since 1980. Figure 1 (which expresses the median pay of directors of all FT-SE 100 companies in successive years as a multiple of average earnings) shows that 15 years ago the average director earned seven times as much as the average worker; and that the differential has since widened to 13 times. The HPE's earnings, meanwhile, have climbed from 12-13 to 30 times the national average.

Or try shifting the focus, and putting the matter another way. Bass offers a fairly typical example. Over the past 15 years, as the first table shows, the company's HPE has seen his remuneration increase more than five-fold - in real terms. Meanwhile, across the country, the average worker's pay has risen just 42%. Stated baldly in this fashion, these are indeed extraordinary figures.

But look also at what has been happening elsewhere.

It recently became possible to compare top executive pay with what goes on in the professions, when in 1995 KPMG announced that its senior partner, Colin Sharman, earned a total of £740,000. This is more than half as much again as the sum awarded to the ill-fated Cedric Brown. It would put Sharman in 32nd place among HPEs in the FT-SE 100, although, measured by income, KPMG would rank only 251st in The Times 1000. Another 18 of KPMG's partners earned over £250,000, suggesting that several of them must be getting more than the top earners in FT-SE 100 utilities like Seven Trent and Scottish Power. Further, there's no reason to suppose that KPMG partners are the best paid accountants in the UK - and there's good reason to believe that top lawyers earn more than top accountants.

Or look abroad. The Greenbury committee did notice - to its credit - that British executive pay seemed not out of line with that of other industrial countries. Figure 2 charts the remuneration of chief executives of industrial companies in different economies - and takes in many firms smaller than the FT-SE 100 whose figures are used elsewhere. This demonstrates very clearly that UK executives earn no more than their foreign counterparts. It is also clear that, at least since 1988, growth in top salaries has been no faster in the UK than elsewhere.

It's true, though, that the comparison makes no allowance for differences in the cost of living. At present - in contrast to the fairly recent past - top ranking British executives also pay less tax than their rivals overseas. If national and local taxes are combined (according to Towers Perrin's survey for 1995) the UK executive enjoys the lowest marginal rate, at 40%, in the industrial world. The US equivalent is 53%, the Germans and French pay 57%, the Japanese 65%. In addition, the British seem at an advantage when it comes to pension arrangements. Again, according to the survey, the typical British CEO will retire on 59% of his final salary, which is better than his Japanese counterpart's 37% or an American or Frenchman's 47% '-if not quite up to the Italian's 80%.

Towers Perrin also confirms that British executive salaries are higher relative to average earnings than in most other countries (see Table 2).

However this is mainly due to the level of average earnings in the UK.

Wages are low in Britain because of lower productivity, and international comparisons suggest that the best way to reduce the gap between highest and lowest would be to increase investment. To hold back top salaries would merely damage national competitiveness further.

But it's not necessary to look overseas - or to the professions - to find comparisons that help explain current levels of executive pay. Back in the early 1970s the spread of earnings between highest and lowest was not unlike today's (look again at Figure 1). The 1970s were a bad time for company directors. They were harder hit by inflation than their employees; they were hammered by the flat-rate components in incomes policies; and profits in general were falling. Since the mid-1980s, directors have been clawing back the differentials that they had in 1970. So recent increases in the pay of the average director can be seen, at least in part, as a long-term process of catching-up.

One reason why HPEs have so convincingly outpaced other directors over the past decade could be that they were among the most severely constrained in the 1970s. Further, reduction in the marginal rate of tax in the 1980s will have persuaded some top people to take a greater proportion of their rewards in cash rather than in more covert forms of remuneration. But why should the CEO of Bass, for example, have earned so much less in 1995 than the heads of BOC or Tate & Lyle, which are smaller companies earning lower profits (Table 1)?

Here, the growing internationalisation of business offers one explanation.

As chief executive of BOC, Richard Giordano was once famous for being the highest paid manager in Britain. This was because the board of BOC, having taken over Airco in the US, considered it necessary to appoint an American to lead the combined group. And with a US chief executive came a US rate of pay. These days US salary scales may also be required to prevent Europeans, like Alex Trotman of Ford, from migrating in the opposite direction.

Levels of shareholding may also account, to some degree, for disparities in top people's pay. It's noticeable that David Sainsbury, Lord Wolfson of Great Universal Stores, Gerry Weston of Associated British Foods and others, do not enjoy remarkably high salaries. However their dividend payments may provide a degree of compensation. Giordano, by contrast, was (and is) a professional manager whose whole fortune has been bound up with the job. Similarly Lord Hanson, Nigel Rudd of Williams Holdings and Peter Wood of Direct Line may feel that their equity holding does not provide a reward in line with their contribution to the company. Therefore they must look for a sort of entrepreneurial wage.

The heads of the public utilities who were vilified by everyone are not self-made entrepreneurs, nor do they lead multinational groups. But neither do they evince particular signs of greed. Table 3 shows the utilities which are members of the FT-SE 100, indicating their size (measured by total assets) and the salaries of their HPEs. Only one company, British Telecom, paid its chief executive more than the median company in the FT-SE 100 in 1994 (Blue Circle which paid its man £523,000); and only one, Eastern Group, paid him more than would appear justified by the size of the company.

If top people's pay in the utilities was rising very fast between 1991 and 1994, salaries in most of the old nationalised industries had been notoriously low and adjustment was virtually inevitable. Even so, the 188% hike at National Power carried John Baker only as far as 68th place in the FT-SE 100 league.

Several utilities' CEOs also had large windfall earnings, of course.

Ed Willis of Powergen made a £1.2 million profit on share options. Baker of National Power and David Jefferies of National Grid both made about £800,000, and Sir Ian Vallance of BT £600,000. These arose from the exceptional performance of utilities shares which couldnot have been foreseen when the options were granted. They were, moreover, once-and-for-all gains after options had been held for anything up to nine years (in Vallance's case). Had these windfall profits been annualised they might have excited less vituperation. The ranking under Total Earnings in Table 3 includes the 'embedded value' of options (ie their value whether exercised or not, as measured by the Sunday Times last year), and does little to affect individual places in the pecking order. The utilities bosses are still rather poorly paid.

Any board of directors which is asked to explain the high (or ballooning) salary of its chief executive will reply that it pays what's necessary to attract and retain the right man (or woman) for the job. It is clear from the inequalities and complexities noted above that this is a thin and highly imperfect market. What's far less certain is not merely how it can be controlled but whether it needs to be. Legislation to impose a version of incomes policy is out of the question, and more disclosure will change nothing: top level earnings have accelerated during the 15 years that they have been fully disclosed. Self-regulation will not curb chief executives' pay: the CEOs of most large companies now have their rewards determined by remuneration committees composed of non-executive directors. It was this body at British Gas which awarded Cedric Brown his famous increase, and so brought the Greenbury committee into existence.

And given the risks to which top executives are exposed these days, Greenbury's recommendation of annual contracts could cause salaries to spurt yet again.

Shareholders do have it in their power to control executives' pay. But the shareholders who count are the institutions and they know that the salary of a chief executive is irrelevant compared to his ability. Most FT-SE 100 companies could double or treble the CEO's pay and it would still not amount to one half of one per-cent of their profits. On the other hand, nothing could benefit a company and its shareholders more than the services of a chief executive who seems to possess the Midas touch.

Anyone who views huge earnings as an 'obscenity' to be expunged is free to make out a case, but there is no reason why company executives should be singled out for special treatment. Weak auditing, lax bank regulation and the massive resulting frauds that have damaged the City's standing in the world - these threaten an important component of the national income. But what British companies choose to pay their top executives has no adverse economic effect. Unlike mad cow disease, British executive salaries have never been seen as a problem abroad. It is a problem we have created for ourselves.

Dr Derek Matthews lectures in economic history at Cardiff Business School.

Table 1. Typical HPEs and the national average wage 1980-1995

£000s Constant Prices

1980 1985 1990 1995 1980 1985 1990 1995

Bank of Scotland 19 88 176 377 100 327 492 911

Bass 66 106 416 753 100 113 334 523

BOC Group 271 883 1,025 1,000 100 230 201 169

Forte 63 105 265 537 100 118 224 392

Grand Metropolitan 54 176 639 907 100 230 627 769

Land Securities 52 106 217 464 100 144 222 411

Tate & Lyle 55 233 568 1,236 100 299 548 1,030

Trafalgar House 80 190 400 555 100 168 266 319

National Average Wage 5 8 13 16 100 111 129 142

Sources: Datastream, Employment Gazette

Table 2. Ceos' rewards

As a multiple of employees' pay

1991 1994 1995

Canada 12 12 12

France 16 15 16

Germany 10 11 11

Italy 14 16 17

Japan 11 10 10

UK 16 16 18

US 25 25 28

Source: Towers Perrin

Table 3. Public utilities in the FT-SE 100


Total Total HPE

Assets HPE Earnings HPE Increase

Rank Rank Rank £000 % 1991-1994

British Gas 10 52 50 512 49

British Telecom 5 27 42 757 41

Eastern Group 87 81 n/a 341 197

National Power 28 68 63 437 188

North West Water 41 79 88 361 151

Powergen 48 75 72 400 96

Scottish Power 78 98 97 255 n/a

Severn Trent 39 91 99 302 90

Southern Electric 83 96 87 285 45

Thames Water 44 89 94 317 52

Sources: Datastream, Sunday Times, 5 November 1995.

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