Russell Lynch: Fair play on pay needed to get companies fit and firing

      Published on Friday, 2 December , 2016      112 Views     

  • UK Business

Seethe quietly at the figure snug in his (or her) upholstered chair in the corner office, who’s just as likely to be playing Minecraft as doing anything actually important?

Don’t underestimate the impact of unfairness in the office and its potential impact.

In an era when FTSE 100 chief executives are paid more than 140 times more than their average employee — around £4.3 million last year — some studies suggest that the increasing inequity in corporate pay is actually doing damage to companies.

The fashionable explanation a few years back for why top executive pay was rising out of all proportion to the rest of the workforce was “tournament theory”.

Senior US economist Sherwin Rosen wrote that “extra weight on top-ranking prizes is required to induce competitors to aspire to higher goals”.

In fact, he went on to argue that “payments at the top have indirect effects of increasing productivity of competitors further down the ladder”. Understandably, this theory was beloved of remuneration consultants everywhere, but a radically different vision emerges from more recent research.

Stanford professor Charles O’Reilly analysed five years of data from 120 public companies, tracking several layers of management from vice-presidents down to general managers.

Some of his findings were striking. In one firm, where the chief executive was overpaid by 50% compared with the industry average and general managers were underpaid by 50%, staff turnover on that lower rung was 18% higher than at the companies where the big cheese was fairly paid.

Aside from the obvious point — that an overpaid boss costs shareholders directly in a higher salary — the indirect cost of the higher turnover  of experienced middle-managers was significant.

O’Reilly also found that pay unfairness can trickle down the management ladder, again at a major cost to shareholders.

In the most egregious example of chief executive largesse he uncovered — where the boss was overpaid by 64% compared with the norm — those on the rung below were overpaid by 26% and general managers by 12%.

But the trickle-down effect didn’t get as far as the guys on the shop floor and — surprise, surprise — that dents morale.

The Chartered Institute of Personnel and Development concluded as much last year in a survey that found 59% of employees “directly demotivated” by the size of the boss’s pay packet.

Just 4% of staff — presumably the ones who fancied a shot at the boss’s chair themselves — thought the rewards on offer for the top job were too low. Above all, we’re human beings, not economic units; we respond to perceived unfairness in the workplace as much as anywhere else.

Researchers also carried out a field experiment in which nearly 200 workers in a company were moved to temporary office space out of kilter with their place in the organisation.

The trainees who lucked out and got the corner office upped their game, while the more senior staff assigned to lower-status space lowered theirs.

This, broadly, is the “equity theory” of motivation in practice: it’s not just about your own pay and conditions, it’s about your status compared to “reference points” like other staff, and the consequent  effect on your motivation.

That leads us neatly on to Prime Minister Theresa May’s pay proposals in this week’s Green Paper.

How will publishing pay ratios showing the gap in earnings between the chief executive and an average employee improve the motivation of workers, even if shareholders are eventually handed more powers to vote against pay?

A ratio seems likely to rub in the unfairness, rather than provoking spontaneous cheers among the average Joes on the shop floor when the boss’s pay falls from 140 times to 130 times what they pick up every month.

Rather than going for short-term gimmicks, more investor engagement is badly needed in curbing the excesses of executive pay behind the scenes, and cheering employees by offering them a bigger stake in success.

The unsatisfactory status quo could harm businesses in the longer term, just at the time when we need them to be punching the lights out.

As O’Reilly succinctly put it: “Tournament theory ignores the consequences of having an organisation filled with losers.”

Category UK Business | 2016/12/02 latest update at 2:00 PM
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