The executive pay gap has its roots in the policies put forth in

The roots of 'price-driven salaries'

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The executive pay gap has its roots in the policies put forth in the 1980s by the Reagan administration in the US and the Thatcher government in the UK. Their political philosophies drove deregulation, privatisation of the public sector and free-market capitalism. Both also took a dim view on labour unions, which ultimately played a role in these organisations’ reduced capacity to advocate for workers.
"If you go back to the early part of that period, it was very common for executives' jobs to be part of a company's overall job-evaluation system. There was one system to evaluate everybody's pay," says Sandy Pepper, an expert in executive pay at the London School of Economics. This month, Pepper published a paper exploring why the pay gaps have opened up between CEOs and the wider workforce.
But he says the previous system "broke down" when executive pay became connected with share prices, and "asset-based rewards" took off under the prevailing neoliberalism. Pepper's analysis of FTSE 100 data since 2000 showed that all-employee pay has increased about 3% a year on average, but CEO pay increased about 10% per year.
Pepper says the underlying logic was to pay the CEO according to a company's financial performance, since they were the most important factor of success. So, on top of basic salaries, CEOs were given performance-related bonuses and stock options allowing them to buy company shares for a set price. Ocado CEO Steiner's 2019 pay packet included a bonus of £54m for realising a five-year "growth incentive plan", which measured the company's share-price growth relative to the FTSE 100. (Ocado declined request for comment.)
At the same time, the proportion of UK businesses owned by individuals dropped precipitously. Shareholders grew in power, and their demand for booming stock prices led to booming pay packets for CEOs – in turn signed off by boards of directors eager to please their investors.
Robin Ferracone, CEO of Farient Advisors, an international executive-pay consultancy, agrees with these "price-driven" salaries. "If you have a good CEO, the multiplier effect can be huge," she says. "So, in principle, median pay for median performance and high pay for high performance makes sense."
Walking on eggshells
However, in reality, the system of calculating CEO remuneration is more complicated. Companies rely on compensation committees, mostly made up of board members and executives from other companies that meet once a year.
Besides the more traditional measures of past experience and performance, committees use benchmarking as a key part of the process – working out how the CEO's compensation will compare to those at similar companies, according to Steven Clifford, a former CEO and author of The CEO Pay Machine. Often the sum will be in the 50th, 75th or 90th percentile, therefore constantly maintaining or increasing pay, he writes.
A study in 2010 in the Journal of Financial Economics concluded this system of compensation committees is accelerating pay inflation "because such peer companies enable justification of the high level of their CEO pay".
Bonuses are then agreed as a way to measure performance, either increasing based on financial measures or provided in sum if specific goals are met.
Both the process for base pay and for bonuses are seen by workers' representatives as problematic because boards, not wanting to upset the leader of their company who could leave or fire them, therefore push up pay.
Janet Williamson, senior policy officer at the UK's Trades Union Congress, argues the system of compensation committees, who often report directly to the CEO, lacks impartiality and should be reformed. "We need to move away from performance-related pay – that's what has led to these increases," she adds.