05 Sep 2017
Professor Alex Edmans questions government reforms that will force UK firms to reveal pay ratio from June 2018
Forcing companies to disclose the pay gap between top executives and average workers could hurt employees, according to Alex Edmans, Professor of Finance at London Business School.
From June 2018, the UK’s biggest firms will have to reveal how much their CEOs earn compared with their average employee. The reforms aim to increase boardroom transparency in publicly listed companies and shame firms with “overpaid bosses” into lowering the ratio.
Professor Edmans said investors could base investment decisions on a company’s pay ratio. Consumers might also use it to determine how ethical a business is and whether to buy its products. But he cautions against focusing too heavily on the numbers.
“The pay ratio isn’t comparable across companies. It’s lower in investment banks than supermarkets, but that’s because mid-level bankers are well paid rather than because executives aren’t. Even same-industry comparisons are misleading – a hotel chain that franchises its brand will have a lower ratio to one that doesn’t.
“Having a ratio establishes the idea that lower ratios are good and higher ones are bad. But a high ratio may be reward for the CEO delivering superior long-term performance rather than being excessive. Indeed, rigorous studies show a positive association.”
A further potential downside to pay ratios is bosses making decisions that hurt workers, according to Professor Edmans. “Outsourcing low-paid jobs, hiring more part-time than full-time workers or investing in automation rather than people are ways in which a CEO may look to improve the pay ratio,” he said.
“They could also raise workers’ salaries while cutting other benefits. Research shows that employees on wages that reach relatively low levels value other perks over remuneration. But benefits such as flexible working conditions and in-house training could be at risk under the new reforms, from CEOs that want to close the salary gap.”
Professor Edmans stressed the need to look at other measures to determine whether pay is fair. These include the CEO’s long-term performance, the firm’s business model (outsourcing, franchising and mix of capital and labour) and other benefits given to workers.
“Stakeholders – investors, employees and customers – mustn’t look at the pay ratio in isolation and they need to understand that it ignores many other dimensions,” he said. “It’s widely accepted that if investors focus on quarterly earnings they miss intangible measures. Moreover, companies may distort their actions to inflate earnings.
“Similarly, an excessive focus on the pay ratio could see companies missing many other determinants of fairness and encourage them to manipulate the ratio.”