From a legal point of view, there is no problem with high executive pay. But companies should look at the adverse impact on employee motivation and on leadership reputation. The perceived injustice of exuberant executive pay also harms your organisation. It might decredibilize its leadership and hamper the execution of the strategy.

The highest pay ratio in the US
The % increase of CEO Pay in the UK.
The % of female CEOs in the FTSE 100 who earn 3,5% of income.

Executive Pay is on the rise. Which role can HR play?

Public Outcry on Executive Pay

CEO Pay has been on the radar for a long time. How much can a CEO earn? What determines the contribution of a CEO and how can we measure that contribution. Articles in newspapers illustrate the public outcry:

The Data

One thing is sure. CEO Pay is on the rise. Equilar has published a list of the 100 highest paid CEOs in the US.These are the observations:

  • 100 million Dollar pay packages are back.
  • Pay of the best paid CEOs is increasing
  • The stretch between the CEO pay and the median employee pay can be as high has 5908. The CEO of Weight Watchers International earned 5908 times the median wage of her employees, mainly due to the low median income.

And also in the UK there has been an increase of CEO Pay. The median pay of chief executives (CEOs) of FTSE100 firms has risen by 11% between 2016 and 2017. Check the research by the High Pay Centre and the CIPD. These are the main conclusions:

  • The mean pay ratio between FTSE 100 CEOs and the mean pay package of their employees is 145:1, which is higher than last year (128:1 in 2016, 146:1 in 2015).
  • Just seven FTSE 100 CEOs are women, an increase from six in 2016 and five in 2015. While women make up 7% of FTSE 100 CEOs, they earn just 3.5% of total pay.

The recommendations of the study is to report the pay ratios immediately and not wait until 2019. The reports pleads for more transparency. Also they recommend that the remuneration committee takes the overall compensation within the organisation in consideration when taking a decision on executive pay. And finally they argue in favour of expanding the evaluation of CEO performance to non-financial parameters.

The Role of HR

Can HR play an influence in this process? Yes it can.

HR should be a member of the remuneration committee. They have the knowledge and the access to the data. They can train board members who do not have an HR background to take a balanced view on executive pay. And of course HR can make the link between executive pay evolution and the practices in the rest of the organisation.

But most importantly, HR can also assess the consequences of the decisions of the remuneration committee on the rest of the organization. The psychology of justice is an important aspect of this. And now that companies are forced to inform the public about executive pay and about the pay ratio, it would we wise to take decisions with the psychological impact in mind.

The Psychology of Justice

From a legal point of view high CEO pay poses no problem. But from an ethical and psychological point of view organizations should think carefully about their executive pay policy.

The psychological impact of perceived injustice is tremendous.

The psychological impact of perceived injustice is tremendous. How can an organization justify an increase of CEO pay when overall income has not evolved accordingly? Remuneration committees had better adopted a more empathic approach and should integrate an analysis of the consequences of their decisions in their decision processes.

There are different kinds of justice. Procedural justice is about the correct and fair application of processes and procedures. This is the kind of justice that remuneration committees often use to justify their decisions/ We have followed the procedure. The remuneration committee has been appointed following the rules of corporate governance. The problem with this kind of justice is that it is not relevant when there are issues with that other kind of justice, namely the distributive justice. If people feel that the distribution of pay is unjust, procedures become irrelevant. And one could say that this is a kind of unhealthy envy, but people who say this do not understand human psychology and the importance of fair treatment.

The argument that the CEO sustainably drives company performance is false, some exceptions taken aside. For instance during an IPO, the perception of managerial quality seems to influence the share price. But this is logical, as there aren’t much data on future share price. So analysts look at the CEO and are influenced by the charismatic qualities. And in general, charisma seems to have an impact on share price (and executive pay itself), but not on overall company performance. On the contrary, high executive pay may even threaten company performance. And as you can learn from the list with newspaper articles, there is increased activism against high executive pay. But it seems to come more from investors than from employees, who are less likely to protest openly against the remuneration package of their boss.

Leadership is a matter of making sure people go in the right direction and are willing and able to perform sustainably. And to do that, they need a context of trust. Exuberant pay and inexplainable pay increases do not inspire trust. And therefore this weakens a leader and it weakens commitment.

Inequality is only justified when the group can benefit as a whole. So the question the remuneration committee should ask is:

“how can we motivate an executive in such a way that he or she wants to join, stay long enough and perform.”

If the answer to the question is only or mainly money, disguised in long term incentives, there’s a problem. Do you want a mercenary or a leader? Do you want to talk money or mission?

From a legal point of view, there is no problem with high executive pay. But companies should look at the adverse impact on employee motivation and on leadership reputation. The perceived injustice of exuberant executive pay also harms your organisation. It might decredibilize its leadership and hamper the execution of the strategy.

Contact us

Sources