Pay it forward: the meaning of company pay ratios

The best-paid CEO in the UK, Martin Sorrell of WPP, was paid £48 million in 2016 – 826 times his employees’ average pay. This was down from 1,336 times in 2015.

In its consultation on corporate governance reform, the Government argued that:

‘…there is a widespread perception that executive pay has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies.’

As part of a package of reforms to tackle excessive executive pay, the Government proposed that companies listed on the stock exchange should report the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year. A ratio of 50, for example, means that the CEO is paid 50 times the average pay in the company.

This post calculates pay ratios in the UK based on available data for 319 companies (most of the FTSE 350). In 2016, the average ratio between CEO pay and average employee pay was 57. The highest ratio was as high as 826 at WPP PLC (a world leader in advertising and marketing services), and as low as 2 at IP Group PLC (a group that partners with universities to build tech businesses based on intellectual property).

Analysis shows that:

  • A company’s ratio is partly predicted by the number of employees: larger companies have higher ratios – they are less equal.
  • The relationship between company size and ratio is the combined result of average pay tending to decrease as company size increases, whereas CEO pay tends to increase with company size.
  • Differences in ratios between companies are also explained by the type of industry they’re in, not just by company size. Some industries employ much higher proportions of highly-skilled, well-paid employees (e.g. finance), while others, like retailers, have large numbers of relatively less well paid staff. The remuneration of chief executives also varies across industries.
  • When looking at individual companies, ratios can fluctuate a lot from year to year. These fluctuations are due to the high volatility of top CEO pay, while pay in the wider workforce is more stable.

Taken together, company size, industry and the volatility of CEO pay can largely explain a company’s ratio, and changes from year to year. Expect these factors to feature heavily in the narrative that companies will be required to provide alongside their ratios.

How are ratios calculated?

Ratios are calculated by taking CEO pay and dividing it by average employee pay. CEO pay is the ‘single figure’ total remuneration of CEOs, which includes salary, benefits, pension, bonus and long-term incentives, whether in cash, kind or shares.

I’ve calculated average employee pay by taking total employee costs and dividing by total employee numbers. Total employee costs isn’t just wages and salaries, but also includes pensions, social security and other remuneration such as bonuses. These items (except social security) are included in CEO pay figures, so it’s right to include them in the ratio’s denominator too.

Ratios and company size

Analysis of 319 companies shows a clear relationship between pay ratios and company size (as measured by the number of employees). Chart 1 below shows that larger firms have higher ratios.

Chart showing ratios and company size. In the chart, larger firms have higher ratios

In this chart, almost half of the difference in pay ratios is explained by company size.

This relationship between pay ratios and company size is the combined result of two other relationships. First, larger companies tend to pay their CEO more. This link is shown in chart 2 below, where company size explains 18% of the difference in CEO pay.

Chart showing relationship between CEO pay and company size

Second, average pay tends to be lower in larger listed companies (this isn’t true of all companies in the economy, where small private companies tend to pay less well than larger ones). This link is shown in chart 3 below, where company size explains 23% of the difference in average employee pay.

Chart showing employee pay and company size

These two links reinforce each other’s effect on pay ratios: larger companies pay their CEOs more while paying their employees less on average, both of which push up the resulting pay ratio.

Ratios and industry

Differences in ratios between companies are also explained by the type of industry they are in – not just by company size.

Some industries employ much higher proportions of highly-skilled, well-paid employees (e.g. finance), while others, like retailers, have large numbers of relatively less well paid staff. The remuneration of chief executives also varies across industries.

The table below shows average pay ratio and pay by broad sector for listed companies with 1,000+ employees.

Everyday consumer items is the sector with the highest average ratio (i.e. pay is most unequal) at 134. This sector covers companies such as Tesco, Unilever, Tate & Lyle and British American Tobacco. These are big companies which pay their CEOs better than average while at the same time having large numbers of relatively poorly paid employees.

Perhaps contrary to expectations, the average ratio in the financial sector is only half that in everyday consumer items – even though finance CEOs are paid the most. The sector owes its relatively low ratio of 66 to its many well-paid professionals, who make the sector’s average pay the highest of all too.

Company-level time series

When looking at individual companies, ratios can fluctuate a lot from year to year. Chart 4 below shows ratios since 2010 for five companies in five different sectors.

Chart showing ratios since 2010 for five companies in five different sectors

These fluctuations are due in large part to the high volatility of CEO pay, while pay in the wider workforce is more stable. Taking Centrica as an example, chart 5 shows how the pay ratio mostly follows CEO pay.

Chart showing how the pay ratio mostly follows CEO pay.

The difference between the CEO pay line and the pay ratio line that opens up gradually is the result of employee pay growing slowly but steadily.

For more info on my methodology and to read about the reforms to corporate governance that the Government is pursuing, see our briefing on Corporate Governance Reform.

 

Photo credit: Lights on Canary Wharf by Davide D’AmicoCreative Commons Attribution 2.0 Generic (CC by 2.0)