Executive pay: is it fair?

20 October 2015 -

The latest guest blog from Professor Adrian Furnham dives into the hotly-debated world of executive pay, looking at the fairness of remuneration and whether we should all know what the CEO gets paid

Adrian Furnham

The issue of executive pay continues to invoke a hot debate, particularly in the financial sector and in these “times of austerity”. We see many expressions of “outrage” as public servants of all sorts from GPs to head-teachers have their “generous packages” revealed.

There is an academic literature on what people know about pay and what they think is fair pay. It can be summarised by three points. First, people are pretty well informed about the pay of different types of professionals as compared to national averages. They know sufficiently what accountant and hairdressers get paid.

Second, nearly all believe that the differentials are too high: the top earners should receive less and the bottom earners more. They understand and approve of differences as a function of skill and responsibility but feel the gap between many professions and individuals too high.

Third, if they are asked to start all over again and devise pay rates for different jobs, there are some surprises: many believe that currently well-paid jobs, such as TV news reading, should be paid well below the national average, while others, such as nursing, should be paid as much as judges. Things have got “out of kilter” for a whole range of historical reasons and need to be “corrected”.

Essentially there are four issues that inform this debate:

First, the amount of (comparative) pay any/all executives should receive. It is well know that satisfaction with pay is all about comparatives and not absolutes: that is, not how much you receive but how much you receive relative to your comparison group. The question is, what exactly is that? There are both internal and external comparators. Most top executives prefer the latter and not the former, but it is the exact opposite for observers.

There have been strident calls for the implication of a policy that means the top job is never paid more than 10 times that of the bottom job within an organisation. This can be rather embarrassing for the board to try to explain how one job is worth so much more than another. Bosses, however, quite like social comparisons. They note the world is now one market and if you are not prepared to pay international market rates, there will be a mass exodus of talent to other countries. There are a lot of these threats but less evidence that they are ever put into practice.

Second, how pay is determined. Again there are various issues: one is who is involved and what mechanism they apply. Is it an in-house remuneration committee, or should a review be conducted by some expert outside consultancy company? What sort of algorithm should be used? For instance, should it be based on some sort of performance measure? How is that to be calculated?

Anyone interested in performance management knows how difficult it is to measure performance. You can choose some metric: time, money, quality, quantity, customer feedback, but there are three problems here: how to get measures for jobs that don’t distort behaviours (see how bus drivers ignore waiting passengers because they are often measured by on-time performance); the contribution of others (teams) to productivity; and macro-economic forces that suddenly occur.

Linking pay to the share-price can also have serious and sudden unfortunate consequences as some CEOs sell properties, re-engineer (sack) middle management, etc. to make the financials look good in the short term, only to have a later crisis.

Third, what form should the salary take? Salary, bonus, shares? Any delayed salary? What about the perks: the house, the jet, etc.? What should be considered part of the total reward package? Most of the debate is about the end-of-year bonus, which may increase their short-termist approach to things. The paradox is that bonuses often make social comparison much easier because of the natural boastfulness of people.

A big problem lies in explicit, usually numerically expressible, rewards. We all know that some jobs are more intrinsically rewarding than others. It is difficult to think what is rewarding about being a traffic warden, and easy to understand why crafts-people seem so happy. But how do you put a price on “quality of life”? We seem only able to do it by “quantity of reward”.

However this should not be an insurmountable problem for social scientists who are familiar with those concepts. It should not be that difficult to come up with a measure of job stress and strain as well as intrinsic rewards. So it may be able to replace the remuneration committee with one that can calculate intrinsic and extrinsic rewards of the job.

Fourth, should pay be secret and confidential or made public? Whilst members of the board can usually hide their salary, the CEO’s salary is nearly always published. Should we also know, by right, the salary of the board?

In some countries this data has to be made open so there is no way to make it secret. And they are characterised by political stability and a general sense of fairness. Secrecy feeds conspiracy, but openness outrage and fury. Paradoxically the hottest issue is comparative pay and how it is calculated. Nothing angers people more than a perceived less deserving person who is paid more than you.

Hence pay secrecy, which is always easier to deal with than transparency.

Adrian Furnham is a business psychologist and author of 80 books and 1,000 scientific papers. He is an adjunct professor at the Norwegian Business School. Find his website here.