October 22, 2019
How much pay is too much?
How to prepare for your 2020 remuneration report
2020 is set to be another explosive year for pay. Those of us who regularly read the UK business pages will be no stranger to reports of UK listed businesses facing ‘public outrage’ or ‘investor revolt’ over pay and benefits levels. But these stories aren’t always consistent about how pay much is just too much. As two-thirds of UK plcs prepare to put a new Remuneration Policy to the vote in 2020, it’s a question that many Boards should consider now.
What level of pay actually triggers outrage? Finsbury, adviser to many of the UK’s leading businesses, conducted new public research and has drawn on behavioural science to find out what levels of CEO pay and perks will cause public and shareholder disquiet – and why.
But before we get into the results, it’s worth exploring how the biases in our day to day decision making affect perceptions of pay.
Take buying a cup of coffee. When baristas ask us what size latte we want, most of us go for the medium sized option. Behavioural scientists¹ have labelled this the ‘goldilocks effect’, because – when asked – people say that the middle-sized option is neither too big, nor too small. But ‘just right’. The interesting thing about the goldilocks effect is that if we increase the sizes of all the cups, so that the middle option is now the size of the original ‘big option’, people still choose it. And they still say that they chose it because they thought it was ‘just right’.
We think we’re making these choices based on objective criteria (the size of the cup). But in fact we’re making a comparative judgement. We go for the middle option because of the way it relates to the other available choices. We tend to make these comparative judgements all day, everyday.
“What behavioural science will tell you about perceptions of company leaders’ pay: it’s all relative.”
How does this relate to executive pay?
When we think about people’s salaries, including our own, we’re often more concerned about relative pay than absolute reward. Think about the banker who receives a £1 million bonus. He or she is initially delighted, but then discovers that everyone else has received £1.5 million. Now the £1 million feels paltry relative to others.
This same phenomenon helps explain why hardly anyone thinks they’re rich, even if they’re in the top 1 per cent of earners, as research by Ipsos Mori for the High Pay Commission has shown. High earners don’t compare themselves to the rest of the population. Their comparison is people like themselves and their neighbours. And they consider ‘rich’ people to include Bill Gates – having too much to realistically be able to spend.
In other words, as you get richer, your comparison set tends to change. You become like the middle sized coffee cup that’s increasing in size at the same time as other cups around you.
The public perspective
And this brings us to the Finsbury research on executive pay which shows exactly the same ‘relative’ phenomenon at work.
In a survey of over 11,000 people² using findoutnow.co.uk:
1. Most were shocked by remuneration most C Suite executives would consider very modest. Over 63% think £800,000 in pay and perks is far too much. This is less than a quarter of the average pay for FTSE 100 CEOs but more than enough to place an executive into the top 0.01% of earners.
2. There are entrenched views at either end of the scale. Around 25% of people believe pay of £80,000 is far too much. By contrast, 18% of people are comfortable with CEOs earning £8 million a year and 15% with them earning £80 million.
3. Despite the chatter about regulation, the instinct that companies should be free to set their own pay levels remains strong. 40% of the people surveyed believe CEOs should be paid what the board decides.
Our behavioural scientists believe that the phenomenon at play here is the same as that of the coffee cups explained earlier. People judge the pay relative to their own experience. The levels suggested here were so far from the average person’s that the ‘shock’ factor kicked in early.
“Most people were shocked by levels of pay that public company CEOs would say were very modest indeed”
“To avoid regulation and political intervention Boards have to be ready to use discretion to prevent inappropriate outcomes”
The shareholder and media perspective
Consistent with the behavioural perspective, shareholders have a different view of what’s right.
Off the record conversations with shareholder advisory groups show that pay becomes ‘just too much’ at a multiple of what the public will tolerate. Investors are influenced by precedent, experience and their own relative salary position – and rely on a different view of what’s average. They are really asking ‘what does everyone else get paid’ and using that marker for what seems appropriate.
In 2018, the median take home pay of a FTSE100 boss was £3.5³ million. If everyone else is paid £3.5 million, then this sum is the equivalent of the middle sized coffee cup that seems just right. The advisory groups say that if the pay for performance link is strong and value is proven then they will question pay above the average and ‘tolerate’ amounts up to £10 million.
We are told that ‘in general’ above £10 million as a total take home amount becomes difficult to justify and above £20 million is probably unacceptable. The ‘just too much’ level, no matter how good the performance, lies somewhere between the two.
Business journalists who write about pay tend take a view more consistent with investors’ than the public’s. Approaching the £10 million level is likely to spark tough headlines although this does vary according to the paper’s own stance and how good corporate performance has been.
Executive pension levels
Last year saw successful campaigns by the Investment Association to bring executive pensions in line with ordinary workers and to stop what many saw as the unfairness of a two tier system. We expect more campaigns of this nature as the pressure grows on asset managers to show their clients they can inspire the companies in which they invest to change for the better.
Politicians and pressure groups will also influence the debate, with any inconsistency between corporate rhetoric and behaviour likely to attract significant criticism. To avoid regulation and political intervention, boards will need to show they are willing to use discretion to prevent excess pay when remuneration formulas create inappropriate outcomes while highlighting the social value created by their companies in a more compelling way.
With the prospect of the Labour Party having more power, the urgency to lead change will only increase. Labour is calling for new models of capitalism, remuneration and company ownership. With an election in the offing and other political parties positioning their own narratives about shareholder ownership, there
is a very real threat to the status quo.
Brace yourself for 2020
The first page a journalist goes to when a company report and accounts drops is the Remuneration Report. Every year, the time Finsbury spends advising our clients and responding to media enquiries on CEO pay increases and the list of issues gets wider. 2020 will be no exception and as around two-thirds of FTSE 100 are bringing a new remuneration policy to a vote, it may get louder.
What does this mean for remuneration committees?
If you have a policy due for a vote this year or you fear your Remuneration Report may meet some scrutiny or a protest vote from some shareholders, it is important to be prepared. Each situation is unique and deserves a tailored approach but some broad guidelines of how to be ready are set out below:
1. Create a project team of your Remuneration Chair, your Head of Reward and your remuneration and communications advisers and discuss issues and messages early. If you are announcing a new strategy or you expect corporate activity like a demerger or restructuring also consider whether you will need to consult shareholders about potential policy changes to align business goals
2. Consult. Seek the opinion of the advisory groups and your top shareholders in good time and listen to their views. Act on their recommendations if you can. Shareholders are increasingly vociferous in the media, and while they are not yet voting in droves against remuneration policies, the trend for increased commentary and ‘amber recommendations’ are here to stay. The proxy advisers all publish advice notes so you should know in advance where the triggers are likely to be.
3. Follow the debate. Have a clear view of what the 2020 hot topics are likely to be and be ready to address them. Or better still pre-empt the issue – bowing to pressure is never a good look.
4. Take advice from your communications experts and consider your relative position. The research above shows that your perception of what is ‘too much’ is likely to be different from the reaction of the media or your employees. Make sure you have an outside view.
5. Face up to the difficult questions before you publish to avoid the protest vote and the row. Is the pay just too much? Are we being fair and consistent? Should the CEO just take the pension cut now? Where are we vulnerable? Should we exercise discretion?
6. Build relationships early. With more scrutiny on boards, chairmen and heads of remuneration committees should consider how they build can build understanding of their thinking well ahead of pay season. Confidence in good remuneration process is often based in confidence in the individuals involved in decision making.
Don’t treat this as just another section in the report and accounts
1. Draft your report as simply and clearly as possible. Use imagery and infographics. Remuneration reports are difficult for third parties to interpret. If you are clear, there will be less frustration especially from the media.
2. Prepare a communications plan and have messaging, back up data about your performance, question and answer briefings and agreed quotes ready to go. Make sure the remuneration report shows that policy dovetails with your strategic and ESG goals.
3. Proactively communicate if you think there may be a story to tell. You are proud of your policy and the way it drives performance. If your CEO achieves their targets it will be a success for your stakeholders. Equally, if you think your report may attract criticism or your shareholders may go to the press consider a more ‘lean in’ approach to your media engagement.
4. Prepare for the proxy group verdict and expect negative recommendations or red tops to reach the media.
5. Consider the impact on employees. Is your Gender Pay Gap a positive to trumpet or does it need to be explained? Has executive remuneration risen faster than the pay received by the rank file? It goes without saying that employees prefer not to read about company developments first in the media.
6. Expect third party commentary. Commentators like Unions, the High Pay Centre, the Government and the political parties and even the Church of England are regularly quoted in the media on pay. Be prepared for interventions from these organisations and be prepared to push back with your own position, if it is the right thing to do.