Can fair pay ever be reconciled with ideas of market and performance-driven reward and is it really ever achievable? Duncan Brown, Director Reward and HR Development, Institute for Employment Studies.

The concept of fairness helps to explain the widespread criticisms of ‘fat cat’ remuneration and underpins much of the current political discourse. But press and social criticism of bankers’ and senior executives’ rewards appears to be at one of its periodic peaks. Business secretary Vince Cable described the growth in FTSE 100 chief executives’ pay packages as “nauseating”, while according to The Observer, “public sector fat cats’ pay should be cut”. In a recent CIPD survey, 42 percent of employers regarded establishing internal equity as one of their top three reward goals and the agreement establishing our Coalition Government promises “fairness and responsibility”.

In pursuit of this, Will Hutton’s Fair Pay Commission was established by the Prime Minister and is considering the introduction of a cap of 20 times the lowest paid worker’s earnings on executive pay in the public sector. Hutton argues that in the private sector too, following the financial crisis, “capitalism will be arranged more fairly in future”. Even in the free-market United States, legislation has been passed requiring quoted companies to publish their top executive’s remuneration as a multiple of average pay in the organisation.

But as all those of us with more than one child will attest, unfairness is easily and frequently claimed but almost impossible to address in practice to everyone’s satisfaction. As author of American comic strip Calvin and Hobbes Bill Watterson puts it, “I know the world isn’t fair, but why isn’t it ever unfair in my favour?” So just what is driving this contemporary crusade, and what does fairness mean in our winner-takes-all economy of six figure Premier League player salaries and bonused, multi-million pound bankers? Does fairness really matter and how can employers try to ensure that their rewards really are perceived to be fair? These are the questions that I will be focusing on in this article.

Thus it is hardly surprising that after the financial bank-shaking crash and subsequent recession, as Financial Services Authority chief executive Hector Sants observes, “there is widespread concern that inappropriate (bankers’) remuneration schemes contributed to the market crisis”. Largely because of the horrendous public relations implications, the government and major banks have been in talks for months to limit the size of bonus pools to a ‘fair’ level, and the FSA’s new remuneration code does place controls on the measures and timings, if not the absolute levels, of bonus scheme payments.

But higher incentive opportunities driving widening pay differentials are not by any means restricted to the financial services sector. Ten years ago the chief executives of our largest quoted companies earned under £1 million on average, equivalent to 16 times national average earnings. By 2008 that had ballooned to over 130 times and £3.5 million. And across the public sector an estimated 38,000 managers earn more than £100,000, with the highest pay ratios as a proportion of lowest earnings in the organisation evident amongst vice chancellors in our higher education institutions. Around 5,000 of these managers earn more than the artificially low salary of the Prime Minister, about the same as the number of banking executives and traders who are estimated to have earned over £1 million in the 2010 bonus round.

Chairs of remuneration committees will give you two justifications for this upward trend: stronger linkages between pay and performance, and the need to reflect external market rates in order to retain their most valuable talents. But accountants PwC reported “an extraordinary and uninterrupted (unfair even?) growth in senior executive pay” over the last decade. Just 23 percent of the variation in chief executive pay was down to variations in company performance.

And a recent report by the McKinsey management consultancy appears to have nailed the myth of the hyper-competitive global market for executive talent (also a common argument used in defence of globally-mobile bankers’ rewards), as they conclude that “the movement of executives between countries is still surprisingly limited”.

Although they are often obsessed with external market data, most board remuneration committees wouldn’t even be able to tell you what the internal pay differentials between the top and bottom in their organisation are, even though a Financial Times poll found that 75 percent of us in this country believe that the gap between rich and poor is too wide. Richard Williamson and Kate Pickett’s best-selling book The Spirit Level presents comprehensive evidence on the negative social effects of extreme income inequality, on everything from crime rates and drug usage to teenage pregnancies and levels of obesity.

But employers have been forced to pay attention to legislation addressing equal, or rather unequal, pay concerns. The Made in Dagenham workers may have won their particular battle for fair pay, but forty years after the Equal Pay Act was passed, the war is far from won. The gender pay gap remains stubbornly plateaued at almost 20 percent, and over 40 percent for part-time workers and in certain sectors such as financial services.

The Equalities Bill, which started to come into force last October, has increased the pressure still further on recalcitrant employers. But government reforms in social care have absolutely reduced the wages of low paid, mostly female care workers over the past decade and some fear the same outcome resulting from the recently announced NHS reforms.

Fair pay matters, at the level of the country and society, as Pickett’s research demonstrates. But it also matters, crucially, at the level of the individual employer as well. Ever since John Stacey Adams published his equity theory of motivation in the 1960’s, a wide variety of research studies have confirmed that above a bare minimum required for subsistence, people assess the adequacy of their rewards not based on an absolute level of remuneration but relative to that of others.

So what can employers do to deliver fair pay and are limits of 20 times the lowest paid really any solution? As the interim report from the Fair Pay Review makes clear, caps can only work as part of a wider fairness strategy and could be inflexible and damaging in a volatile economy. President Barack Obama has pointedly not repeated his Democratic predecessor Bill Clinton’s initiative to limit non-performance-related executive pay in the US to $1 million. This only encouraged inflation up to that level, as well as the development of the current multitude of complex and in reality not-very-performance-related bonus plans (although the President did cap the pay of his senior officials).

Absolute ratio caps could also just encourage the further outsourcing of low paid and predominantly female-held jobs by UK employers, reversing the impact of the national minimum and now so-called ‘living wage’ movement, and widening the differentials between the ‘haves’ and ‘have less’, and men and women even further. Action in these three areas would generally support fairer pay outcomes.

The first area is communications and improved transparency. The Fair Pay Review should define the optimum measure of internal pay differentials and government should require public bodies, and encourage private and third sector employers, to annually publish this internal pay ratio, alongside of disclosure of their gender pay gaps and senior executive packages. This would enable informed and sensible comparisons between organisations to be made, and help to develop our understanding of what is driving the growth in differentials, its effects and the actions to be taken in response. What do employers have to hide?

Second is management and governance. As the Senior Salaries Review Body recommended last year, all public sector bodies should have independent remuneration committees. Some type of High Pay Commission, possibly based on the SSRB, should define and support the introduction of common pay bands at senior levels across the public sector. Private sector employers meanwhile should reverse the trend of removing senior executives from the job measurement and pay structures applying to their other employees. This erodes any sense of common treatment and furthers the supposedly market-driven escalation of executive pay.

Laventhal’s work demonstrates that the policies and processes of pay setting, such as base pay and bonus structures, have an important influence on people’s sense of relative fairness, as well as satisfaction with their absolute pay level. Firms should also monitor the outcomes of their pay and bonus decisions, checking that often unwittingly, important groups of staff are not being systematically unfavourably or unfairly treated.

Third is inclusion and involvement. Recent national attitude survey data showed that a quarter of those dissatisfied with their pay and bonus levels said that it was because their amounts were below what their senior managers get. Heavily involving employees in pay decision making, particularly when changing arrangements, and providing them, where possible, with a financial stake in the organisation, are both strongly associated with positive employee engagement and business success.

Having asked employees to share in the recessionary pain, employers now need to make sure they give employees the opportunity to share in success and any future gains, rather than just operate with distinct and restrictive executive and sales incentive plans. John Lewis seem to succeed pretty well with no executive bonuses and a common profit sharing arrangement which enfranchises all of their employees. And the all too common, vapid intranet propaganda on attractive total rewards packages just aren’t convincing or motivating anyone in the current climate.

The twenty times pay ratio cap for the public sector is just one possible element in a framework for greater pay fairness which is set out in the Hutton Review’s interim report, incorporating improved communications and governance and better talent management of staff. But employers shouldn’t need politicians or legislation to force them to pay attention to fairness, for it lies at the heart of the engagement and performance of their workforce.

All the major political parties, recognising the mood of the electorate, went into last year’s general election claiming to be the upholders of fairness. “What does it say about the values of our society” asked the new Labour party leader Ed Miliband recently, re-emphasising the theme, “that a banker can earn in a day what a care worker earns in a year?” The nineteenth century Prime Minister Benjamin Disraeli put it more succinctly as the need to deliver “a fair day’s pay for a fair day’s work”.

Duncan Brown, Director Reward and HR Development
Institute for Employment Studies
www.ieshr.co.uk