Chief executive pay: is it tied to performance in the UK?

Conference meeting room
The LSE’s Centre for Economic Performance has been looking at the evidence on Chief Executive pay in the UK. Their conclusion? It is tied to performance – and is more tied to performance than it used to be. But it is a lopsided link with smaller cuts when things go worse than the increases when things go well. What’s more, when things go well Chief Executive pay rises much more than pay for others.

In more detail, here’s what they conclude:

CEOs earn around 40 times more than the average employee, but this multiple rises to around 80 when we look only at the very top companies – the FTSE 100. The majority of pay for CEOs comes from bonuses and stock incentive plans, whereas 95% of employees’ pay comes from basic salary.

Our evidence also shows that when corporate performance improves, so does pay. But pay goes up much more for CEOs than for ordinary employees. For example, if the firm’s value as measured by shareholder returns increases by 10%, CEOs on average get an extra 3% in pay while employees get only 0.2% more.

This close pay-for-performance link among CEOs seems to be a fairly new development. Evidence from the 1980s and early 1990s found almost no link between pay and performance for top executives. Our research shows that today’s correlation between pay and performance is driven by bonuses and other incentive packages, which have become more important in recent years. We also find that poorly performing firms are much more likely to boot out their CEOs, and that when a firm does badly, CEO pay goes down.

But it is worth noting that CEO pay cuts for failure are not as speedy as pay increases on the upside. So although it is true that CEOs are not just ‘rewarded for failure’, they get more pleasure when the company’s performance goes up than pain when performance goes down.

Although this work looks at Chief Executives, they have previously pointed out how the issue of high pay is a broader one:

As for the causes of better or worse links between senior pay and performance, they conclude:

There is a strong relationship between how tightly firms link CEO pay with performance and how significant institutional investors are among the firms’ shareholders. For firms with low levels of institutional ownership, we find no link between pay and performance in general, although CEOs in such firms do benefit when performance is good.

That is an important conclusion for Vince Cable’s current work looking at the rules for shareholder power. As for the politics of this, MORI’s data from 2008 is still very relevant:

The higher your personal income, the more likely you are to under-estimate how well off you are compared to other people in Britain.

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