The Business Secretary, Greg Clarke has announced a series of corporate governance reforms, including a requirement for companies to publish the pay ratio which measures the pay of the CEO relative to the salary of their average UK employee. The aim of the reforms is to make companies more accountable to their employees and shareholders.
The big question is: do employees and shareholders care?
Research on American companies suggests that employees don’t care, at least not in the way we might think. Faleye et al (2013) show that productivity is not affected by high pay ratios, except that is in companies with fewer employees. Interestingly, in these companies a high ratio spurs employees to greater efforts and productivity improves. Higher pay ratios are also good news for shareholders, because company value increases with the pay ratio.
So is anyone apart from the government and media, upset by high pay ratios?
The answer may be consumers. Unpublished research by Mohan et al (2015) shows that in experiments where consumers were told about relative pay, they were willing to pay higher prices for the same product if it was sold by a company with a lower pay ratio. In other words they wanted to punish firms that paid their CEOs “too much”.
If consumers are motivated to seek out the new data (a big “if”) and use it in their buying decisions this could affect profitability and company values, at which point shareholders and CEOs will have to become far more concerned about relative pay in British companies.
- Faleye, O, Reis, E. and Venkateswaran, A. (2013) The determinants and effects of CEO-employee pay ratios, Journal of Banking and Finance, 37(8) 3258-3272
- Mohan. B., Norton, M.I. and Deshpandé, R. (2015) Paying up for fair pay: Consumers prefer firms with lower CEO-to-worker pay ratios, Harvard Business School Working Paper no. 15-091