Pay ratio reporting set to be a risky business

Legislation looks set to come into force in 2020 which will compel the UK’s largest companies to publish and justify the pay ratios between their CEOs and workers. Its introduction was first announced by business secretary Greg Clark in August 2017, as part of a series of corporate governance reforms.

The new reporting requirements will include a disclosure of the ratio between the pay of a company’s CEO and that of its median employee, as well as proof that directors have taken into account the interests of all stakeholders in their business – not just investors.

What will your employees think?

The current ratio of CEO pay to average full time worker pay in the FTSE 100 stands at 120:1, and the mandatory publication of individual pay ratios will push the issue into hard focus for employees and customers, in many cases for the first time.

A survey by Willis Towers Watson, a multinational risk management, insurance brokerage and advisory company, found that just 58 per cent of British workers thought employee performance was fairly reflected by their pay. And with wage growth witnessing an unprecedented squeeze, living standards think tank the Resolution Foundationhas warned that real wages are set to reach their lowest point in more than 200 years by 2021.

Against this backdrop, the announcement of a disproportionate gap between executive and employee wages risks causing considerable damage to morale. Even without a high pay ratio, half of a company’s employees will not be happy to learn that they compare unfavourably to its median wage. It’s possible that salary negotiations will become more arduous as a result, with an increase in employee turnover and more wage demands tied to pay gaps.

Context is king

Measuring CEO pay is complicated. In addition to annual salary and bonuses, benefits such as pensions and long-term incentives must also be taken into account. Plus, the bigger the company, the harder it becomes to calculate the median employee’s pay. Global companies must negotiate differing currencies, full-time/part-time roles, pensions, bonuses, profit-sharing plans and more. This is a lot for any company to handle. That’s why a lot of busier global businesses have started investing in outsourced payroll support, from companies like cloudpay, to ensure that all of their employees are paid correctly. When a business is operating at a global level, it’s vital that their finances are correct. This is why many of them outsource a lot of their work to ensure it’s accurate.

Combined with complex reporting requirements, this can offer opportunities for companies to ‘game’ the system by excluding certain incentives or groups of employees in order to achieve a more favourable ratio.

The Confederation of British Industry (CBI)requested that the legislation include sector comparisons, but was turned down. Its reasoning was that companies need to account for industry differences. Sectors with large numbers of low-paid staff will report inflated pay ratios compared to banks, for example, where the difference between CEO and worker pay is not as great, but overall remuneration is much higher.

This highlights the risk of reporting pay ratios in isolation, without benchmarking them against others either within or outside the industry. Without this context, sensational media stories could increase consumer concerns, leading to boycotts and reputational damage.

Self-governance versus legislation

Private companies have previously existed in a world where they could choose their own governance framework, free of any obligation to disclose their approach. Organisations will need to accept a more progressive and transparent outlook on executive pay, which includes reporting whether they comply with the UK Corporate Governance Codeor an alternative, as well as demonstrating more openness and being held accountable for their governance decisions.

However, when the legislation was announced, it was heavily criticised by opposition parties for not being robust enough. Prime minister Theresa May’s original proposals for mandatory inclusion of workers on company boards have been watered down, while Labour leader Jeremy Corbyn suggested capping executive pay to 20 times the average worker for companies with public sector contracts.

As a consequence of closer scrutiny by the government, companies must be able to properly explain and justify their approach to executive pay, or risk further legislative action to clamp down on what is perceived to be irresponsible or unjustifiable governance practices.

Communicate about compensation

Pay ratio reporting will become an annual opportunity for consumer pressure groups and unions to highlight anger around executive pay, especially where companies have not performed well that year.

Global PR firm Edelmanrecommends that companies ensure they’re able to clearly communicate how their median employee wage and CEO benefits package was calculated, and if possible how they tie to company goals. The firm highlights the importance of checking whether an organisation is an outlier – something which should be on all risk managers’ radars. It also suggests preparing messaging around comparison to peers, giving consideration to intangible aspects such as employee experience and career development.

The requirement for companies to be more open about their governance arrangements will soon become a statutory one, but the sentiment behind the legislation comes from an increasing sense of social justice felt by the public and fanned by the media. Nevertheless, investors are heavily influenced by a company’s treatment of its employeeswhen it comes to willingness to invest, which means getting pay ratios right – and reporting them correctly – is now a decision of real strategic significance and an issue that should be closely monitored by risk managers.

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