Outraged about executive pay? Calm down – the market’s taking care of it

Rising executive pay has long been a rallying cry for leaders on the left. But they needn't worry, says Matthew Lynn. The trend is going into reverse.


WPP's extravagantly paid Sir Martin Sorrell

Fat cat CEOs. Rewards for failure. Widening inequalities between the boardroom and the shop floor. In the last two decades there has been a huge rise in what the people running companies get paid, and a widening gap between their rewards and what their shareholders and staff are making.

Even many people on the centre-right have started to worry that that might be bad for the system as a whole, and it has fuelled the rise of ever more extreme and populist leaders on the left. But, away from the limelight, something is under way that, so far, very few people have picked up on. That trend is going into reverse.

The rise of the CEO

There is no question that running abig company has become a lot more lucrative over the last two decades.By 2014, the average FTSE chief executive made £4.3m a year, an increase of 73% over the last decade. That is roughly £1,100 an hour, meaning they made as much in a couple of days as the average worker makes in a year. And yet, over the same decade, the FTSE hardly moved. It is still no higher than it was back in 2000.

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The pay of average workers went up a bit in the 2000s, but has stagnated since 2008. If you wanted to make a lot of money, the easiest way to go about it was to work your way up to the top of a quoted company. The people there took a larger share of the pie than staff or shareholders, even though it was hard to see much evidence that their businesses were any better run.

That trend seemed relentless until this year. This month, a study by the pay consultants Towers Perrin found 64% of Europe's leading chief executives received no increase in their salary, and their median pay remained constant. Earlier this year, a report from Pricewaterhouse Coopers found that the pay of chief executives was also just about static: 45% of CEOs received no pay rise at all, and the median total pay rose by just 0.7%.

If pay was stagnating across the economy, that might not be very surprising. But of course that is not what is happening. After a five-year squeeze, living standards are now rising again. Average wages are up by 3% this year, much more in line with long-term trends. At the same time, dividends rose by 6.8% this year.

It doesn't take much knowledge of maths to work out that, with CEOs getting nothing, and the staff and shareholders getting more, the gap is going to start narrowing. True, it is going to take a long time to get back to where it was before the pay explosion started. But it is at least starting to travel in that direction again. There are at least a couple of reasons for thinking the trend might last.

The role of the watchers

Firstly, shareholders have become more actively involved, scrutinising pay more closely. That is partly because tougher disclosure rules have given them more power, and partly because it has become easier to do so. It is a while since the 'shareholder spring', when a series of high-profile pay packages got voted down, and at the time it didn't seem to have made a great deal of difference.But it may simply have been burning on a slow fuse.

CEOs can no longer simply award themselves massive pay rises with impunity. There is at least the threat of some resistance from the shareholders and that may well have moderated the excesses. After all, we all behave slightly differently when we know we are being watched and scrutinised. And CEOs are now being watched closely.

and the shoppers

More interestingly, there might be subtle pressure from customers. A new study from the Harvard Business Review showed that customers reacted negatively to companies where CEOs' pay was way too high, and gradually abandoned them. In the test, people were given a range of products and some information about the companies that made them. Where the CEO was paid outrageously, they were more likely to reject the product.

Is there any evidence of that happening in the real world? It is hard to say. Some of the most extravagantly paid CEOs, such as WPP's Sir Martin Sorrell, are not in the consumer sector. But there may be some truth in it. All the high-street banks are starting to lose market share to the new breed of challengers. It is unlikely that their extravagant boardroom pay has helped them. Most markets are more intensively competitive than ever, so image matters more than it used to.

There have been plenty of calls formore regulation of CEOs' pay.New disclosure rules are constantly being dreamt up. On the left, there have been regular calls for higher taxes to redistribute money away from the highest paid. In Switzerland, there was even a referendum on a legal limit on the pay differential that could be permitted between the highest- and lowest-paid person within any company. In France, they tried taxing top earners at 75%.

But right now it looks like the marketis taking care of the issue just fine.It may be a long time before we get back to the relatively egalitarian (by today's standards) 1950s. There is still going to be a huge gulf in what different people earn. But for the first time in a while it is staring to narrow and so long as that is true, we hardly need any more rules or higher taxes.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.