The disparity in pay between the UK's top directors and average workers is now at a "tipping point" where society and the economy are being undermined, a year-long study by the High Pay Commission (HPC) has found. Over the past 30 years, the rewards in the corporate sector have flowed upwards, the report said, creating a society blighted by inequality and poor social mobility.
The top 0.1% of society remain isolated from the financial downturn, the report said, while household incomes across most of the country have remained stagnant at best. The gaps between rich and poor were in danger of approaching "Victorian" levels, the report warned.
“There’s a crisis at the top of British business and it is deeply corrosive to our economy. When pay for senior executives is set behind closed doors, does not reflect company success and is fuelling massive inequality it represents a deep malaise at the very top of our society," Deborah Hargreaves, chair of the commission, said on Tuesday.
Jobless rates in the UK have reached highs not seen since the early 1990s, and youth unemployment now stands above one million. High inflation and slow wage growth have reduced the spending power of average households, and small enterprises have suffered from a drying up of credit at the lower end of the market.
Sales of consumer staples and clothing at high street retailers have had a bad autumn, showing only marginal recovery into the winter shopping period. By contrast, luxury goods and multimillion pound properties have defied the downturn, with companies such as Louis Vuitton Moet Hennessy and Burberry posting strong results through 2011.
The discrepancy in pay is fuelling social inequality that risks creating political instability, the HPC's report said. Beyond that, however, it creates economic imbalances, damages social mobility and deters entrepreneurship and growth, according to the report. Unequal societies are less insulated against economic shocks and recover slower, academic research has shown.
A report from the New Economics Foundation, published earlier in November, said that a combination of entrenched wealth and connections, globalisation and liberalisation, a skewed labour market profile, and the taxation and political system created a cycle of growing inequality in the UK.
"Income inequality in the UK went up very rapidly in the 1980s. There was a huge widening of income inequality in that decade. It carried on in the 1990s, but that growth was less pronounced. It was primarily driven by those at the very top and the very bottom of the distribution… and we certainly haven't become more equal since," Paul Sissons, a researcher at the Work Foundation, said.
"There's evidence that high levels of overall inequality can lead to some quite damaging impacts, including poorer health outcomes. It's also been linked to high crime rates, higher levels of drug abuse, larger prison populations and higher levels of teenage pregnancy."
There is also a business case for making executive pay more transparent and more in line with the rest of the workforce. Co-operative Asset Management was one of a handful of shareholders that opposed the pay deal agreed for Barclays' CEO Bob Diamond - which handed the former investment banking head a £1.35m basic salary.
In October, a report by Income Data Services (IDS) showed that the total earnings among directors at FTSE 100 companies increased by almost 50% in 2010, despite a financial and economic crisis which hit growth and employment. The average total pay deal for a chief executive among the largest listed companies was £3.8m, up 43.5% in the year. This compared to a 2.7% increase among average employees.
"There seems to be an ongoing problem… of a decoupling between performance and pay, with executive remuneration spiralling and generally losing all connection towards company strategy or their key performance indicators," Abigail Herron, corporate governance manager in Co-Op Asset Management's responsible investment team, said.
Defenders of executive pay say that the UK needs to continue to reward its top directors in order to retain its international competitiveness. Speaking to Sky News after the release of the IDS report, Sir Martin Sorrell, head of the media group WPP, said that curbing remuneration would leave Britain "with less competitive, less well-run companies... If that’s what you want, fine, that will be the end result and Britain on the world stage will be even less competitive than it is now. So don’t crimp those companies that are trying to build global operations competitively."
Herron does not entirely disagree. "You do need to pay high levels… but that must be accompanied by high and long term levels of performance to justify that payout," she said.
A large part of the problem is transparency, Herron said, who echoing the HPC report. Executive packages have become more complex and more opaque, meaning that even professional investors sometimes struggle to work out why directors receive the incentives that they do.
One of the measures proposed in the HPC report is compelling public companies to report the ratio between the top executives' pay and the median earnings of the workforce. Herron said that she has recently become a convert to this idea.
"I didn't really used to have much time for the pay ratios disclosure discussion, but I think it's fair to say in the last few months I've had a road to Damascus change of mind on this," she said. "One of the main reasons it's useful is that it's undoubtedly the case that remuneration packages are increasingly complicated, whereas pay ratios are very easily understood.
"I think it would be very helpful to have a few key pieces of data that would flag up the outliers to us."
Herron added that she would also like to see more disclosures on executive pensions. In June, IDS showed that FTSE 100 directors had on average £2.8m in final salary pension pots.
"Pensions of executive directors tends to be squirrelled away in the remuneration report… there doesn't seem to be much talk about it in corporate governance circles. The remuneration and pure quantum tend to grab all the headlines, but you see for some executives there will be some really impressive increases in their pension benefits, and often its at the same point that the employees are being downgraded to a defined contribution, whereas the executives are enjoying a fairly healthy payout or accrual through their defined benefit scheme," she said.
The HPC recommended 12 measures, many of which focused on publishing more information on earnings distribution within companies. It also said that investors should disclose how they vote on remuneration packages, and that "remuneration consultants" who advise on executive pay packets need to take action to reduce conflicts of interest. A permanent body to monitor high pay should also be created, the report said.
“The excessive rises in executive pay are clearly unfair," Lord Dick Newby, high pay commissioner and co-chair of the Liberal Democrat's Parliamentary Treasury Committee said. "They bear little or no relation to improvements in long-term company performance. This is particularly corrosive at a time when millions of workers are feeling the pinch… It is crucial that the proposals are now adopted by the Government without delay.”
Chuka Umunna, Labour's shadow business secretary said: “As the High Pay Commission report highlights, we need responsibility at the top as well as at the bottom of society. While it is right that those who work hard, generate wealth and create jobs for our country are rewarded, where failure is rewarded or people award themselves huge pay rises that bear no relation to performance or what their companies can bear, trust is severely undermined."