As world of corporate governance, nothing stands still”.1

As Peter King recentlywrote, “in the world of corporate governance, nothing stands still”.1Legislative bodies, regulatory agencies, and international organisationsconsistently seek to improve corporate governance issues. And yet, as we bearwitness to the largest and arguably most successful global coordinated effort toenforce compliance within corporate governance, the prevalence of executivecompensation remains an issue of great proportion. The UK government hasrecently responded on a national level in regards to such issues, submitting threespecific measures to be incorporated as legislation into the UK CorporateGovernance Code2(the “Code”). This paper will critically explore such measures in relation totheir potential effect in combatting excessive executive pay and pay withoutperformance, demonstrating that while the aim of these legislative measures maycreate greater transparency and employee protection, the underlying methodologyby which these aims are to be achieved remains flawed and therefore unlikely toproduce the intended results. Before analysing the government’sproposals, it is prudent to first understand the context surrounding executivecompensation and why it remains at the forefront of corporate governancereform. Scholars argue that the bulk of executive compensation debates began inthe 1980’s emerging in parallel with the ‘agency theory’, that is, theseparation of ownership and control with the interests of the former beingpitted against the latter.3 This quintessential ‘agency relationship’,although addressed in legislation and soft law measures, nevertheless remains acontroversial issue – most notably when executive compensation becomesuncorrelated to company performance.

4 It canbe said that the following addendums to the Code are intended to resolve suchcontroversy. The first measure of the government’sthree-prong approach to executive pay is the mandatory requirement of listedcompanies to annually publish and justify the pay ratio between the CEO andaverage UK worker’s pay. This legislative measure can be assumed to tackle theissue of companies being disconnected from their performance as well as theworrying lack of transparency, both key concerns addressed in Theresa May’sintroductory comments. In particular, this measure is used to address the factthat UK CEO’s earn 129 times more than the average worker, as well as ‘Fat Cat Wednesday'(Jan 4th), the day by when a CEO has already earned more than anaverage worker earns during the entire year.5 Unfortunatelyfor the May government, there is little empirical evidence supporting thepotential effectiveness of this first measure.6In a peer reviewed studyconducted in 2016, it was noted that although the financial media and popularpress frequently denounce what is perceived as a large and growing gap betweenCEO and median pay employees, pay ratios are generally much lower than levelsdiscussed in the press.

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7Furthermore, the study found that “pay ratios do not inform shareholder voting ordirector elections”8,indicating that other factors within the firm may be the cause for shareholderdissatisfaction. With that said, however, there is no denying that mandatorydisclosure of a pay ratio can be helpful in creating transparency as well asproviding a mechanism to assess the reasonableness of executive compensation.9Nevertheless, the government should not remain complacent in believing that payratios are the only issue contributing towards shareholder dissatisfaction, andfurthermore, that disclosing them will have any substantial effect towardsminimizing the gap. A potentially detrimental effect to UK businesses coulddevelop if companies, in light of these disclosure requirements, were toimprove the ratio by outsourcing lower paid jobs. This would simply circumventthe pay ratio scheme, frustrating parliaments objective altogether while also subjectingthe job market to considerable hardship. To take one step further, thesuggested pay ratios might not have any real effect in circumstances wherecompanies have relatively acceptable or even small pay ratios but continue tocompensate executives unjustly (i.

e. performance targets missed, share pricesfall, yet compensation rises).Beyond this, and thenegative implications which may arise, is the notion that pay ratios as a wholeare an unfair comparison10; thatis, critics of pay ratios argue executives work in unstable and complex marketplaces and therefore their remuneration appropriately reflects this.11 However,advocates of pay ratios rightly note that excessive pay can be highlighted by agiven pay ratio12,leading to the objective sought by the government. Nevertheless, while the governmentsaim to crackdown on excessive pay makes a positive headline contributing to itspolitical platform, it is important to bear in mind that executivecompensation, to a large degree, is set by public markets and therefore comparingaverage worker salary against CEO pay runs the risk of disrupting effective marketforces at play. The governments secondlegislative action is to publish on a public register those companies thatreceive greater than twenty per-cent opposition to executive pay packages. Thiscan be seen as an extension of the already implemented ‘say on pay’ measures(albeit non-biding), thereby giving further weight to shareholderdissatisfaction when it comes to executive pay packages. At first glance this policysounds promising; however, central to its methodology is the idea of publicshaming.

Tom Gosling, leader of PwC’s UK Reward Practice notes, “the idea thatpeople are going to be shamed into paying top executives less by a givenratio….is fanciful”.13 Acountering view might argue that public shaming is an effective behavioural toolbecause it could inflict negative sentiment. Conversely, the likelihood oflong-term meaningful consequences, that is, enough to reform remunerationpolicy is slim since the measure is more analogous to a soft law measure (lackslegislative teeth). In other words, the provision doesn’t require the companyto change; it only relies on negative sentiment from investors. Legislationthat relies on negative public sentiment is not an adequate strategy.

Therefore, unless the government were to impose a mandatory reduction ofcompensation after significant shareholder disproval, the current proposal isunlikely to produce the desired results. Furthermore, and beyondthe limited effect of the public register is the inherent flaw of pay ratiosaltogether. That is, pay ratios are misleading representations of a company’sremuneration framework due to the complex nature of public companies withintheir respective sectors. To demonstrate, consider the following data from theHigh Pay Centre on the ratio of chief executive to average employee pay.

In2016 Lloyds Banking Group paid its CEO £8.5mwhich was 200 times the £42,719 average pay ofits 75,000 employees, but Goldman Sachs, a sector competitor, paid its CEO $21mlast year (roughly twice as much as Lloyds), but was only 45.5 times the$460,889 average pay of its 6,149 employees.14 This comparisonclearly establishes that pay ratios are misleading statistics; therefore,unless the number of employees and respective salaries accompany a ratio, a payratio alone will not produce the intended results.

Furthermore, not only will payratios be ineffective in achieving their aims, they also have the potential tomisinform investors with inaccurate (statistical) representations of a company’sremuneration framework. Assuming the May government is aware of theseshortcomings, one can only deduce that the notion of transparency is supreme.However, this paper maintains that transparency is only as good as theinformation it reveals. The third and final updateto the Code is intended to strengthen representation of employee interest mandatingemployee representation on a board level. Scholars contend that companies whomaintain and encourage employee involvement at the managerial level are moresustainable and more likely to exert long-term performance.15 Furthermore,Germany’s adoption of a similar approach, the use of a two-tier board system,one of which represents employee interests, has brought considerable economicand social success16 -giving added authority to the governments proposals. However, while evidence existsto support these measures in enhancing employee protection17, thesame is not true in reducing excessive and unjustified executive pay. Therefore,inherent in the government’s policy are two fatal assumptions.

First, itassumes that employee and executive interests are at odds with each other; andsecond, that the employee director or advisory council will act as a barrier tolimit excessive and unjustified pay. With respect to theformer, consider an average employee to demonstrate; he/she likely desires jobsecurity and career advancement, two things which are inextricably linked to acompany’s success. Therefore, while it is a logical consequence that a company’ssuccess will be met with additional remuneration, such remuneration is not tobe discouraged by employees since the more success the company bears the morelikely the employees interests are to become realised. Therefore, employee/executiveinterests are not binary. In regards to the second assumption, critics might arguethat the employees will want the distribution of profits (i.e. executivecompensation) to be more fairly distributed within the company and willsubsequently act to moderate excessive/unwarranted remuneration.

However, evenif you were to reduce executive compensation of one of the highest paid18 (£22.4 million) UK CEO’s, Arnold Donald of CarnivalCruise Line to nil, and distribute it evenly amongst its 120,000 employees, thenet result would only be an extra £186.67 peremployee. Therefore, given the absence of any practical justification forreducing CEO compensation from an employee perspective, it is highly unlikelythat an employee represented board will take action against pay regimes as themoney saved would not have any material impact on employee interests within thecompany.

Under the proposedmethodology of pay ratios, public registers, and employee represented boards,it has been demonstrated that failing a more robust hard law strategy, thegovernment is unlikely to see a reduction is excessive compensation and paywithout performance. It has been established that without the appropriateinformation, pay ratios will not produce their intended effect of disclosingcorporations with unreasonable pay gaps; in fact, pay ratios alone can giverise to conflicting information leading to a total and completemisrepresentation of a corporation’s remuneration framework. Furthermore, inregards to the public register proposal, it has been demonstrated that such astrategy is too reliant on negative public sentiment leaving it without thenecessary legislative teeth required to implement meaningful long-term change. Thepenultimate paragraph demonstrated that although employees will be betterrepresented at the managerial level with the third legislative measure, thesame would not effect excessive pay and pay without performance as a result oftwo fatal assumptions. Going forward, the May government must be cognisant ofthe drawbacks of pay ratios, public registers, and employee represented boardswhen addressing executive remuneration and instil a more robust, hard lawapproach if it wishes to achieve its intended results.

    1 KingPeter, Pau Lauren, ‘Disclosure of executive remuneration in the UK: recentdevelopments and US comparison’ (2013) 1 2 UK Corporate Governance Code, 2016 3 Bebchuk Lucian, Fried Jesse, ‘ExecutiveCompensation as an Agency Problem’ (2003) 17 JEON 77 4 BebchukLucian, Fried Jesse,’ Paying for Long term Performance’ (2010) 139 UOP 65 EdmansAlex, ‘Why we need to stop obsessing over CEO Pay Ratios’ (Harvard Business Review, 2017) <>accessed Dec 3 2017 6″Empirical investigation of pay inequality within firms is challenging due tolack of publicly available data” Mueller Holger, Ouimet Paige, Simintzi, Elena,’Within-Firm Pay Inequality’ (2017) 30 RFS 3608;The only other country thathas implemented this measure is the United States through Section 953(b) of the Dodd Frank Act.  Although the SEC’s proxy disclosure rules areintended to educate investors, the Center on Executive Compensation notes that”the pay ratioprovision does not provide material information to investors, would beextremely costly to implement and is inconsistent with the purposes ofcompensation disclosure in a company’s proxy statement” CottinghamJan, ‘CEO vs. Worker: New Rule Requires Pay Ratio Disclosure’ (2013) 30 AB 13  7 CrawfordSteven, Karen Nelson, ‘Mind the Gap: CEO-Employee Pay Ratios and ShareholderSay on Pay Votes’ (2016) BSB 27 8 CrawfordSteven, Karen Nelson, ‘Mind the Gap: CEO-Employee Pay Ratios and Shareholder Sayon Pay Votes’ (2016) BSB 28 9 Lacmanovic Sabina, ‘The Relevanceand Effects of the Executive-to-Worker Pay Ratio Disclosure’ (2013) 26 JDUP 174 10 MarinoBiagio, ‘Show Me the Money: The CEO Pay Ratio Disclosure Rule and the Quest forEffective Executive Compensation Reform’ (2016) 85 FLR 1362 11 Bloom Mark,’The Performance Effects of Pay Dispersion on Individuals and Organizations'(1999) 42 AMJ 3712 FerrariniGian, Moloney Ned, ‘Executive Remuneration in the EU: The Context for Reform'(2005) 21 OREP 318 13 Oakley David, O’Connor Sarah, ParkeGeorge, ‘Theresa May’s plan to expose boss-employee pay gap flawed’ (FinancialTimes, 2016) accessed Dec 4 2017 14 Kalinina Elena, Patel Katherine,Shand Louisa, ‘Research Report: Review of FTSE executive     pay packages'(2017) HPC 4  15 Salazar Alberto, Mohamed Munthana’The Duty of Corporate Directors to Tie Executive Compensation to the Long-TermSustainability of the Firm’ (2016) 12 OLS 12 16 FranksJulian, Mayer Colin ‘Ownership and Control of German Corporations’ (2001) 14RFS 94917 AddisonJohn, Teixeira Paulino, Zwick Thomas, ‘German Works Councils and the Anatomy ofWages’ (2010) 63 ILRR 249 ?  18 McLay Rebbeca, ‘Highest-Paid CEOsin the UK’ (Investopedia, 2017) accessed Dec 18, 2017 


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