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Stephen  Bevan

Coalition Government sets cap on ‘excessive’ incomes

Authors: Stephen Bevan Prof Stephen Bevan

24 January 2012

You could be forgiven for being unfamiliar with Section 953(b) of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. In fact, if you are familiar with it, you really should get out more. For everyone else, the important thing to know is that it includes a provision that is intended to make US company pay dispersion more transparent. Specifically, it requires companies to disclose the ratio of CEO-to-worker pay for their median employee. By passing this provision, the US Congress sought to address the public’s concern that runaway CEO pay had contributed to growing workplace inequality and that those at the top were lining their pockets when ordinary Americans were losing their jobs or taking pay cuts.

It’s worth reminding ourselves that the Dodd-Frank measures to promote pay transparency were implemented in the USA, where any measures which even hint at the regulation of free markets or the stifling of unfettered wealth creation usually provoke apoplexy among many in both Wall St and the wider political classes. Income inequality in the United States during the past decade has risen to levels not seen since the 1920s. The increase of income inequality leading up to the 2008 financial crisis and is especially noteworthy. For example, between 1993 and 2008, the top 1% of Americans nabbed 52% of all income growth in the United States

Meanwhile, back in the UK, the Coalition Government yesterday showed its commitment to impose a very clear cap of its own - but in this case on the incomes of 67,000 families who are on benefits worth a total of 26,000 or more. A decisive, unambiguous, if controversial, move which sends a clear message about what the government regards as unfair and demonstrates that it is determined to get tough on excess. On the same day the same government announced that, despite the lead given to it by our cousins across the ‘pond’, it didn’t feel able to commit itself to imposing even the requirement to report (not limit) the ratio of CEO earnings to median pay. This is despite being in favour of a 20:1 ratio in the public sector. It was an announcement which disappointed many of those who argued for a tougher message to be sent to those UK boardrooms which appear disconnected from their workforces. One of the only concrete changes in what Mr Cable announced was a subtle shift in the rights of shareholders to vote down proposals to increase senior executive pay at Annual General Meetings.

The problem with this is that executive pay has grown most rapidly during the last decade: a decade when shareholders already had power over its excesses. And we can’t reply on the massed ranks of small shareholders to vote down big pay rises for CEOs. The proportion of UK shares owned by individuals fell from 47% in 1969 to 10% in 2008, while the percentage of shares in foreign hands has risen from 7% to 42%. Most individual investors today hold their shares in nominee accounts, mainly because doing so is more convenient and less expensive. The consequence is that a company will never know the identity of most of its individual investors, won't have them recorded on a register and won't send company information to them. This means that highly paid pension fund managers (on the same high pay ‘gravy train’) and foreign investors (no interest in executive pay as long as equity values continue to increase) will have most ‘clout’ under the new arrangements.

Of course most employees will have a view about whether their executive teams are worth their salaries. But they won’t be able to express a view which has any influence because proposals to allow employee representatives on remuneration committees were also rejected by Mr Cable. Yet the sense of natural ‘justice’ in most organisations is very strong. The irony is that it has been known for a long time that people often over-estimate the pay that others receive, particularly when they are separated from them in the pay scale. So when executive rewards are kept opaque, there is evidence that people judge the distribution to be more hierarchical than it actually is. Thus, becoming more transparent about pay structures and systems might demonstrate that things are less unfair than people might think they are.

Ultimately, what matters to people is that both pay levels and the process of determining them are seen to be fair. People want clarity about how decisions about pay are made and a sense of justice about the outcome. Mr Cable has missed the opportunity to signal to employees that he understands or values these instincts.