'Fat cat' pay - can it be justified?

In the climate of ever-growing strikes and discord in all sectors of UK industry, Matthew Gorrie takes a look at the issues surrounding 'fat cat' pay.

Still today, and perhaps indeed more than ever, the “fat cats” at the top of the tree are a common image within public perception of companies and management structures, so it is hardly surprising that CEO and senior executive pay remains an extremely controversial topic. It is a view that seems to be backed up by evidence however, with the average FTSE 100 CEO being paid 109 times the salary of their average employee – in some cases reaching ranges of up to 656 times this amount (Prospect Magazine). Not only that, but it is a phenomenon that stretches beyond the UK: in the top 350 US companies, the average CEO earns approximately 351 times the salary of the average worker (EPI).

With the cost of living crisis taking its toll on much of the world, it is clear to see why many people feel there is a fundamental unfairness in this level of remuneration. Added to this is the fact that the situation is becoming more extreme rather than more egalitarian: the ratio in the US has moved from 31 times in 1980 to 61 times in 1990, then to 351 times in the present day (EPI).

There have been many attempts to explain this high increase in pay – in particular, some have argued that the job of a CEO has become more complex over the latter part of the twentieth century and the early part of the twenty-first century, especially as companies became increasingly globalised.

This does, however, give rise to two fundamental questions:

• If the job of CEO (or at least board-level management) has become increasingly difficult then why haven’t other worker’s salaries also risen by a comparable degree? Are we to believe that that senior board members are the only ones who have seen their jobs become increasingly complex? Has no engineer, accountant or developer seen increasing complexity in their roles?
• Has there been an equivalent increase in productivity and profitability? One would expect that with such a high rate of pay, we would see a resultant improvement in the performance of companies.

Unsurprisingly, there is extremely limited evidence that CEOs are the only ones who have seen the complexity of their workload grow. It is clear, in fact, that the online environment has made certain jobs ever more complex and time consuming. There has been no increase in employee wages to reflect this, however, and the evidence in fact suggests that real wages in the UK have dropped since 1980 (IER). It would be very difficult to put forward a sound argument stating that economic growth in the UK is purely a result of CEO actions – so does it not appear fair that workers should gain some share in increasing economic growth?

As a result, we must also ask the question why shareholders appear willing to pay senior executives such increasing amounts of money. There has been a traditional belief among several investors that CEOs possess a unique set of skills that allow for corporate growth. From this point of view, therefore, a high salary can be very much justified if it allows for corporate growth and shareholder returns.

There is also limited evidence to suggest that simply paying more for a CEO is necessarily a route to improved performance. For example, John G. Stumpf left Wells Fargo bank in 2016 with a pension fund apparently worth $22.7m despite leaving a legacy of fraud and almost collapsing the institution (LA Times).

Even in successful companies, there is also limited evidence of how much of corporate performance can be attributed to CEOs. Prior to the 2008/09 financial crash, some financial institutions exhibited record profits – only to then suffer collapse during the credit crunch. Certainly, it appears that company performance is dependent on a much broader set of economic and social factors than simply CEO performance in many cases; thus, a culture that rewards or punishes CEOs as the primary factor seems flawed.

How, then, does this situation resolve itself? In large part, a change in the attitude of the institutional investors who hold the majority of listed shares is necessary, although it is clear that this is not something we can expect to happen overnight.

In a business school setting, it is therefore vital that we take a role in encouraging the board members and investors of tomorrow. It is essential that we encourage students to show a true spirit of enquiry and investigation, ensuring that leaders are rewarded only for adding true value to an organisation.

About Matt Gorrie

Matt is a Teaching Fellow in the Department of Accounting and Finance specialising in financial reporting and governance & ethics. A Chartered Accountant, Matt previously worked as an auditor with both mid-tier and big 4 accounting firms as well as teaching for the Institute of Chartered Accountants of Scotland.