10 October 2017

Facts and myths in the pay debate

Evidence is a critical guide to executive pay policy and practice

For a while I’ve been writing a regular blog on executive pay and other corporate governance matters. With the debate on pay structures still rumbling on, and imminent changes to UK regulation and the UK Corporate Governance Code there is more than enough to discuss.

I hope I’m be neither a craven apologist for current practices nor an unthinking critic. What I aim to do is to help you follow the evidence and so draw your own conclusions (although I always make my point of view clear!). 

This point on evidence is one I want to emphasise in this post. Executive pay is an area where there’s so much data you can find a statistic that proves almost anything. But much of the analysis that makes the headlines is simply not rigorous and would not stand up to scrutiny in any peer-reviewed academic journal. Countless “studies” that become prominent in public discourse are based on selective interpretations of the data and weak methodologies. Confirmation bias - where people look for any evidence that supports their view, and filter out anything that undermines it - is endemic in this area. As result, much of what is commonly held to be true about executive pay is, in fact, incorrect, or at least severely misrepresented.

This is a shame, because there’s actually a really good body of rigorous academic evidence out there on executive pay. This is one of the things I’ve learned over the last year or so as a member of the Steering Group of the Purposeful Company Taskforce, working with the highly respected Alex Edmans, Professor of Finance at London Business School. The evidence doesn’t tell you everything, and a weakness is that much of it is focused on the US market. But executive pay is one of the most heavily researched areas of corporate governance, and there’s a lot we can learn from the very good work done in Universities and Business Schools around the world.

Earlier this year we published Executive pay in a world of truthiness. This looks at four common myths in executives pay, that often go unquestioned in the UK, but which aren't borne out by the best research evidence.

Myth 1: Companies ignore shareholders on pay

In fact, companies receiving more than 20% vote against their remuneration report increase their vote one year later by 17% points on average. Only 2% to 3% of companies either lose a vote or get more than 20% vote against for two years in a row.

Myth 2: The increase in CEO pay over the last three decades is unjustifiable

80% of the increase in UK CEO pay since the early 1980s can be explained by the six-fold real increase in size of a typical FTSE-100 company since that time. 

Myth 3: There’s no link between pay and performance

Most analysis of pay and performance ignores basic adjustment for company size and fails to take account of the impact of previously awarded equity. Allowing for these two factors, performance explains 80% of the variance in total CEO pay in the UK. 

Myth 4: Incentives don’t work

Research shows that incentives do influence CEO behaviour - not always positively. High and long-term shareholders, however, are found to encourage better long-term performance.

I’ll explore each of these over the coming months, while also sharing views on issues such as trends and developments in pay design and disclosure, pay fairness, changes to the UK Corporate Governance Code, shareholder engagement and stewardship, and other developments.

I wrote this article while a Partner at PwC so references to ‘we’ and ‘our’ should be taken to refer to PwC