Inequality is back in the spotlight as the US Securities and Exchange Commission prepares to vote on pay ratios. For the first time, America’s largest businesses could be forced to publish how much more their chief executives earn than the average worker.
The disclosure, required under the 2010 Dodd-Frank Act, has long been in the pipeline. If voted in, businesses can expect the new rules to inspire greater levels of scrutiny. Research by Harvard Business School shows people have no idea how much CEOs earn and, when asked, grossly underestimate their boss’s pay. In the US, CEOs earn up to 300 times more than the average salary, yet most estimate the gap to be a fraction of this, at 30 times the average wage.
The Dodd-Frank Act comes at a time when tackling pay gaps has shifted from being an ethical question to an economic threat to national competitiveness. The OECD recently reported that the pay gap is at its widest in over 30 years in member states, the highest level since records began. Last year, the organisation’s research showed that income inequality has a “statistically significant impact” on economic growth, costing the economy 9% of GDP growth between 1990 and 2010; the US lost 7%.
An inevitable conclusion
It’s not surprising many people conclude that big businesses are to blame for this when daily headlines juxtapose revelations of rising executive pay alongside stories of how falling wages are trapping low-paid workers and their families in poverty, even in supposedly wealthy nations.
Multiple polls show pay gaps are eroding public support for corporates, and this could be costing them money. Another recent study by Harvard Business School suggests that big pay ratios could be costing large companies more than public goodwill. It found that to garner the same level of consumer preference, a firm with a high (1000:1) ratio would need to offer a 50% discount compared with a firm with a low (5:1) pay ratio.
Even luxury goods companies are concerned. “We cannot have 0.1% of 0.1% taking all the spoils,” said Johann Rupert, chairman of Cartier-owner Richemont, during a recent speech. “And folks, those are our clients. But it’s unfair and it is not sustainable. So I don’t know what new social pact we’ll have, but we’d better find one.”
A new social pact
For some, the Dodd-Frank disclosure is arguably a step towards that new social pact and its strength is its simplicity: it enables businesses to objectively show what fair and equality-promoting employers they are by using a single set of digits. In Canada there is even a kitemark standard that employers with low ratios can use.
Some US companies, including oil and gas firm Noble Energy, have decided to test the waters ahead of the proposed new rules. Some UK businesses are also voluntarily embracing it as a way of building their corporate reputation and differentiating themselves from competitors.
In June, Sacha Romanovitch – the incoming CEO of City accountancy firm Grant Thornton – announced that she would be capping her pay at a maximum of 20 times that of her average worker. Chief executives at FTSE 100 firms typically earn 149 times more than the average worker, according to pay equality think tank the High Pay Centre.
Romanovitch says: “The decision flowed from thinking about the purpose of our business; why we exist, how we create value for the world. As an accountancy firm, we can help create a vibrant economy built on trust and integrity, but to make a real contribution to that means every one of our 5,000 employees has to feel engaged.”
For Romanovitch, reducing Grant Thornton’s salary disparity was a logical step, but a personal one: “I thought, what is it I can do personally to make a statement of intent, to signal I’m serious about leading a purposeful business?” The company also plans to introduce a profit share scheme that could boost salaries by 25%. However, there was no magic formula behind the 20:1 pay ratio Romanovitch chose. She says she just went with what “felt right”.
The move has sparked a debate that business leaders are watching closely, according to Luke Hildyard at the High Pay Centre. Businesses in unpopular sectors are asking if Romanovitch’s attempt to “restore trust and integrity” in the financial sector could benefit their own, he says. “We met recently with a large energy provider which recognised they can’t distinguish themselves from the competition on cost, so are considering how they could win public commendation as an ethical business for introducing fairer pay.”
Hildyard points to TSB’s decision to publish its CEO-to-worker pay ratio (65:1) when it spun out of Lloyds Banking Group in 2013 as a further example of how companies are beginning to build their reputation on a fair pay platform.
The reality is that differences in income are determined by global dynamics beyond the control of any single business. A fully globalised economy, where low-skilled workers are widely available and being increasingly replaced by automated processes, inevitably pushes wages down. Meanwhile, the talent pool of individuals with the right experience to lead vast global corporations is so small, it inevitably pushes top executive wages up.
Big businesses are part of these market forces but they are not the cause. In any case, focusing solely on pay ratios risks masking more than it reveals. Often, large gaps can reflect the nature of the industry more than the character of the company. Big retailers, for example, which provide vast employment opportunities for low-skilled workers, will inevitably have much higher ratios than a management consultancy employing smaller numbers of highly skilled staff.
Another problem of comparing average worker-CEO pay ratios among FTSE 100 companies, for example, is that it tells you little about how much a business is contributing to income equality in the UK domestic economy, since the majority (77% according to 2013 figures) of business done by FTSE companies is done overseas.
Equitable pay structures
While ratios attract headlines, Romanovitch recognises they are “not the only game in town” when it comes to addressing wage inequality.
Some businesses are seeking instead to make a positive contribution to wage inequality by elevating those at the bottom of the pay scale and focusing on fair pay progression at every level. Furniture business Ikea, for example, has just become the first UK retailer to introduce the living wage.
It will cost the company £7.5m, according to HR manager Pernille Hagild. “We haven’t looked into pay ratios between our chief executive and our average workers,” says Hagild. “It’s an interesting idea, but we think it’s more important to have a robust process around bandings.”
This may strike many as valid. Nevertheless, UK businesses with high-earning executives can expect to face tough questions as the public grapples with a growing pay gap that seems unjust.
If wage ratios are too simplistic, what does leadership on income equality look like? What would a globally coherent position on fair pay mean for local markets? How can businesses close pay gaps while remaining competitive? How can a company take positive first steps towards closing these gaps and be open about that without exposing itself to attack?
These are hard questions, but answering them is critical, not least for businesses still dealing with ongoing public anger over corporate tax affairs. It could well become the test for businesses wanting to show they are strengthening the fabric of society, not undermining it.
First published on the Guardian