UK Unveils Regulation Compelling Large Firms to Disclose, Explain Pay Ratios

UK Unveils Regulation Compelling Large Firms to Disclose, Explain Pay Ratios

Amid growing public and investor concern about major British companies potentially overpaying their top executives, the UK government has been kicking around the idea of instituting a pay ratio reporting rule since last year. The government hinted in April that it would propose the regulation soon, and now it is here. The proposal, which Business Secretary Greg Clark is presenting to Parliament today, will require all companies with more than 250 employees to disclose the ratio between the pay of their CEO and their average or median employee, as well as to explain this difference, the BBC reports:

The new rules, as well as introducing the publication of pay ratios, will also require listed companies to show what effect an increase in share prices will have on executive pay, in order to inform shareholders when voting on long-term incentive plans. … Mr Clark said: “Most of the UK’s largest companies get their business practices right, but we understand the anger of workers and shareholders when bosses’ pay is out of step with company performance.”

The plans were welcomed by the Investment Association – that represents UK investment managers – as well as business lobby group the CBI and think tank the High Pay Centre. Chris Cummings, chief executive of the Investment Association, said investors wanted greater director accountability and more transparency over executive remuneration.

That investors are leading the charge for transparency on executive compensation is unsurprising; activist investors were also key proponents of the pay ratio reporting rule that came into effect in the US earlier this year. Shareholders are voicing greater interest in exercising their “say on pay” prerogatives, particularly after recent scandals in the UK over executives receiving massive bonuses, in some cases without company performance justifying them.

The Trades Union Congress, the UK’s trade union federation, welcomed the proposal but insists that it’s just a first step. The TUC continues to press for more extensive corporate governance reforms that would give employees a greater role in decision-making, TUC General Secretary Frances O’Grady tells the Guardian:

“Fat-cat bosses are masters of self-justification and shrugging off public outcry. New rules are needed to make sure they change. We need guaranteed places for worker representatives on boardroom pay committees. That would bring a bit of common sense and fairness to decision-making when boardroom pay packets are approved,” she said.

In late 2016, Prime Minister Theresa May had proposed adding worker representatives to boards, but walked back that proposal, later saying employee representation would be encouraged, but not mandated.

Assuming it goes ahead, the UK’s pay ratio disclosure rule will face many of the same questions its American counterpart has: How do companies determine that average employee, for example, and how do various forms of compensation like equity and benefits factor into their calculation of the CEO’s salary? The US rule only requires companies to publish the CEO’s base salary, discounting the majority of top-earning CEOs’ income, which comes from capital gains on the stock they own. This has raised questions about how useful the rule will really be to investors in understanding if their portfolio companies are rewarding their chief executives appropriately.

In these regards, the UK government and employers in that country may benefit from the lessons learned in the US, but each company affected by the rule will still have to figure out how to manage its employees’ reactions. Employees don’t necessarily mind that their CEO earns a lot more than they do, but publishing a median employee salary instantly tells half your workforce that their pay is “below average,” and they will want to know why they earn less than their colleagues. In light of that, the requirement that companies explain their pay ratios as well as disclosing them may be redundant in many cases, as employers will often feel compelled to give an explanation to their employees and shareholders anyway.