Pay differentials exist in all societies, even those labelling themselves as communist. Most people do not rationalise pay gaps in any objective or scientific way, although everyone does seem to accept that people should be rewarded differently because of their skills and effort.
But sadly, all too few of us question the practical benefits, disbenefits, and mechanisms at work in pay structures or the ethical basis for wealth and income distribution.
Let us start with the true basis for differentials and work outwards to its popular rationalisation. The hierarchical structure of commercial organisations is based on command structures. Power is concentrated at the top and thins down towards the bottom. With power comes the ability to acquire more of the wealth generated by the organisation. Ironically too, although it seems that competition increases the higher up the organisation an individual goes, competition is actually greatest in the middle of the organisation, as people push their way up and jockey for career goals. At the top the rules are different: merit does not necessarily hold sway, the gates blocking movement up the chain are fewer and easier to control, and even large salaries – because held by so few people – do not add much to the overall
payroll cost. There are also less people in the command structure to question reward packages, and more scope for the mutual approval of high rewards. Institutional investors are part of the same exclusive demesne and are loath to “rock the boat” so long as the business continues to deliver their dividends.
The CEO persona survives by being remote (how many CEOs are household names?), surrounding itself with mystery and ensuring that pay determination machinery – such as top hat job evaluation schemes – are in place to justify the rewards received. The fact that CEO and board salaries are now commonly published in annual reports and accounts means very little. These are difficult for ordinary people to wade through and also rely on the peculiarly effective stratagem of “hiding in full sight”.
The fact too that senior management is paid through a massive step change in reward from the managers and other employees below them still does not, however, explain why the remuneration of the CEO is usually a further massive step change higher than other colleagues on their company boards. What is the reason for this? In his interesting article “Seven steps to becoming a dictator” (Psychology Today), Mark Van Vugt has pointed out the importance of a strong ideology supporting the notion of absolute rule. Without a single figurehead and a unifying ideology, the notion of an appointed top management team would crumble, in the same way that a noble needs a monarch to justify their lesser positions. Having a huge pay differential at the very top not only creates lots of space for improving board member personal rewards, but also pushes way beyond all doubt the supremacy of the individual who is guarantor of the corporate nobility.
Of course, there are some top executives where no limits need apply – other than ability to pay. Take, for instance, the case of Richard Branson or Larry Page. No one would doubt that those who have built such a huge empire from nothing in an honest way should reap the rewards of their entrepreneurial risk-taking. But they are wholly different top executives from the ones that have achieved their position largely by grace and favour in a large public corporation. How can some of the extraordinary reward packages they receive ever be justified by factors such as ingenuity, skill, or risk? That is why checks and balances are so important when determining CEO pay and equally why board remuneration committees should be chaired in a genuinely independent way.
There is no set formula that can be used to calculate how someone in a top position should be rewarded. If it amounts to a simple process of comparing the packages of those in similarly sized companies, then the logic becomes circular and lacks legitimacy. Tax remains an important factor when considering the level of reward, as high progressive tax bands can heavily diminish the most generous-seeming package. Moreover, the ratio of CEO pay to any other group is not even the primary issue for a position that is generally only temporary and, once lost, leaves the individual concerned sometimes unemployable. That is perhaps why an increasing proportion of CEO reward is now taken in the form of bonus. In fact, although much criticised, the “golden parachute” is by far the fairest and most effective way to compensate a CEO. If the parachute exists, they may feel less worried about taking calculated risks and hence act more as if they were a true entrepreneur.