How pay ratios will affect the average worker

Large companies will soon have to reveal the pay gaps between their chief executives and average UK workers, thanks to new parliamentary laws.

Under the new rules, UK firms with more than 250 employees will have to disclose the salary gaps or pay ratios on an annual basis starting from 2020.

“Most of the UK’s largest companies get their business practices right but we understand the anger of workers and shareholders when bosses’ pay is out of step with company performance,” said Business Secretary Greg Clark, when the new legislation was announced.

“Requiring large companies to publish their pay gaps will build on that reputation by improving transparency and boosting accountability at the highest levels while helping build a fairer economy that works for everyone.”

The pay gap widens

According to research from the Chartered Institute of Personnel and Development (CIPD), the current mean pay ratio between FTSE 100 CEOs, for example, and the mean pay package of their employees is 145 to 1. The gap has widened from 128 to 1 in the previous year and the mean pay for a CEO across all FTSE 100 companies has increased by 23% over the same period, from £4.58 million to £5.66 million.

“It’s important to understand the scale of pay gaps within the UK economy. Why have they occurred and why are certain workers valued so much and other workers with different skills in different sectors valued differently?” says Luke Hildyard, director of independent non-party think tank the High Pay Centre.

“It [publishing pay ratios] will raise awareness amongst workers and that will raise a little bit of pressure to close the gap.”

To narrow the gap, firms have the choice of lowering the pay of top earners or raising that of the average worker. As chief executives are likely to be disinclined to reduce their salaries, says Hildyard: “It does create a little incentive to increase the pay of lower paid and middle-income earners – which is something we want to do as a country.”

The impact of publishing pay ratios on society

The disclosure of pay ratios could also prompt discussion about how society and employers’ improve the skills and bargaining power of lower-paid workers in order to address the gap.

“Hopefully the debate about executive remuneration will trickle down the rest of the organisation and there will be a fuller debate about what the organisation values in terms of employee behaviour, skills, performance and attitudes and how these, in turn, will be recognised and rewarded,” says Charles Cotton, the CIPD’s performance and reward adviser.

“Organisations must have open discussions with employees. When more money is being given in the annual pay round, they need to explain why this is happening and help them understand if this is appropriate.

“If you are able to justify your reward decisions and if they are based on logic and fairness you should be in a better position [than organisations were they aren’t].”

A need for different types of pay ratios

To fully understand remuneration culture at a company and understand the context of pay packages, AAT believes more than one type of ratio needs to be published: the ratio between the highest and lowest pay in the firm, the ratios between management tiers, and the ratio between the CEO’s pay and that of the median employee.

“The mean is easier to calculate but the median is a more meaningful metric,” writes Phil Hall, AAT head of public affairs and public policy, in January’s CPD guide.

“It is often argued that a hedge fund or investment bank would be likely to have a very high median pay level, and so their pay ratio may be low and therefore considered impressive. In contrast, a retailer with a large number or relatively low-paid shop floor workers would face the opposite problem.

“A comparison between the highest and lowest-paid employee would go way towards addressing this problem.”

Greater transparency of executive pay and how it compares to the rest of a company’s workforce will likely lead to a debate about other payments received by top earners, such as bonuses and long-term incentives that are supposed to reflect the performance of an organisation.

“This could raise issues around how performance is defined and whether success is down to the one person at the top of an organisation or everyone and therefore whether everyone should be recognised in a similar fashion,” explains Cotton.

The importance of transparency

In earlier CIPD research, only a third (32%) of employees surveyed agreed their CEO is rewarded in line with organisation performance and 59% cited high CEO pay in the UK as a demotivating factor at work. Experts agree that simply disclosing pay ratios may not go far enough for the average worker and the fight against income inequality.

In terms of stopping excessive chief executive pay, AAT’s own corporate goverenance survey in 2017 found that only 21% of AAT members felt introducing the disclosure of pay ratios would make a difference.

“If nothing else was done on top of the regulations being introduced so far, executive pay culture and practices and pay gaps would not be that different in five years’ time to what they are now,” says Hildyard.

In addition to the introduction of pay ratios, the government has also announced that companies will have to report on how their directors take employee and other stakeholder interests into account. Greater representation of employee interests at board level is a welcome move but for many critics falls short of introducing workers’ to company boards as previously proposed by Prime Minister Theresa May.

Similarly, the AAT has argued that pay ratios should be mandatory, imposed on companies and apply to chief executives’ reward packages as a whole, in order for the average worker to truly feel their benefit.

Laura Oliver is a Freelance Journalist and Former Head of Social and Community at the Guardian.