Executive pay plays a pivotal role in prioritising business direction to achieve specific results. Ensuring alignment between these results and consequent reward payouts is something most organisations grapple within the current business environment. Getting the balance right requires thinking of remuneration as a strategic investment, not just a cost.
Over the last few decades, the quantum of pay for senior executives has grown significantly through all phases of the economic cycle. Seismic changes, such as increased globalisation and digitisation, have widened the pay gap between entry and top executive levels.
Understandably, this disparity has become a highly sensitive matter that is hotly debated across social media and various political forums.
Commentators often highlight the growing pay inequality and disparity as part of a wider societal problem. Some even consider it as one of the fundamental weaknesses in the capitalist system.
The growing disparity
However, the causes contributing to the pay gap are often misconstrued. In reality, it is the market
demand for skills, and the local or regional business conditions that create this demand, which drives the disparity in salaries. Inequality in pay scales cannot simply be attributed to wilful unfair pay practices.
At the lower end of labour markets, automation and offshoring have enhanced productivity and reduced the need for such labour, slowing the increases in pay. Meanwhile at the higher end, there is a shortage of talent with critical technical skills and proven leadership experience, as well as high levels of emotional intelligence and learning agility to cope with an ever-challenging environment.
The supply-demand availability of such a diverse range of skills at the upper echelons is equally imbalanced, in turn accelerating the pay gap.
The cost of living can further amplify this effect as jobs at the lower end are paid a “local” wage, while jobs at the higher end operate in a global market. As such, the lower the cost of living in a country, the wider the pay gap.
For the Singapore market, the pay gap between employees at the entry-level, mid-management level and chief executive officer (CEO) level is shown in the box, “Singapore: Comparison of Fixed Salary (Median)”.
In Singapore, the fixed pay multiple between an entry-level professional and mid-management is around 5.7 times, while the difference between an entry-level professional and CEO level is closer to 15 times. This is close to the practice in the US, but significantly higher than in Western European countries. However, these multiples only address the fixed pay component. Should the variable pay component (short-term and long-term incentives) be added to the analysis, the multiple for entry level professional and CEO pay in Singapore would be significantly higher, closer to 35 times.
When compared to other fast-growing countries in Asia, such as China, India, Indonesia and Thailand, however, the pay gap in Singapore is far lower. The average difference in fixed pay multiple in these countries is between 30 and 40 times between the entry-level professional and CEO level. For these countries, total remuneration multiples (including variable pay) between an entry-level professional and CEO often range around 60 to 70 times.
Broken linkages to business outcomes It is not just the quantum of executive pay that raises eyebrows, however. Rather, the concern over pay levels tends to focus on the lack of correlation between pay and business outcomes and results.
Korn Ferry’s analysis of the top 150 mainboard organisations in Singapore reveals that CEOs’ fixed pay has moved up by 12 per cent over last year. Whilst the average move in total variable cash (consisting of bonuses) has been more modest, at around 5 per cent, the increase for total compensation (consisting of long-term grants and stocks) has been mostly negative, citing the performance of the stock market. See box, “Singapore: CEO Pay Trends vs Company Performance”.
Yet when we consider organisational performance: while the total revenue for these top 150 mainboard companies increased by 6 per cent, total profits and market capitalisation have reduced by 11 per cent and 6 per cent respectively. In this context, a 12 per cent fixed pay rise for CEOs appears to be very high.
It has hence incurred the anger of activists, media, shareholders and the general public. This is especially in light of the fact that general market fixed pay increases have been moving in the range of 3 to 4 per cent.
Interestingly, as performance declines, the amount of guaranteed cash within the CEO’s package as part of the overall pay mix (as a proportion to pay at risk) has increased from 2017 and 2018.
The market conundrum
How did this situation come about? In some cases, organisations are at the mercy of the market when it comes to pay. Sometimes the mounting pressure to retain a senior executive or a CEO due to a lack of alternatives pushes up individual pay, even though the organisation would not be delivering immediate results. Supply-demand pressures mean that organisations need to continue significant pay investments in hope for future returns.
As a result, pay gaps may not come down soon and the perception of reward will still be centred around cost, as linkages with business results and outcomes slowly reduce.
So how can boards communicate this difficult message, both to the public, investors, shareholders and the company’s own employees?
It is important that organisations proactively manage communication and view the design of executive pay plans from different perspectives.
Key considerations when it comes to designing executive pay plans include the following.
- Pay and strategy alignment. The degree to which the executive pay structure supports the company’s short-term and long-term strategy.
- Shareholder and stakeholder alignment. The degree to which the executive pay programme motivates executives to achieve good long-term outcomes for all stakeholders.
- Pay and performance alignment. The degree to which the company’s relative payouts on an annual and long-term basis align with the company’s relative performance.
- Pay data and decision-making. Data and benchmarks provided to the committee to support decisions on pay levels.
- Efficiency and effectiveness. The degree to which the use of the company’s equity is cost effective and share efficient.
- Hot button issues. The presence of programme features that get disproportionate attention from shareholders and watchdogs alike.
The way ahead
To enable all employees to believe in the merit of these plans, the board of directors should take the lead to clarify these critical issues.
First, the board should seek to understand all factors at play and plan for the future. Local market forces are not the only factor influencing the size of senior executive pay. The industry and the operating model are important factors to consider too. As a result, it is imperative that organisations have a firm understanding of the current market competitive position and a strategy for all jobs, especially those at executive level.
The board should play a more proactive role in managing and controlling executive pay, especially when a clear link to business results is absent. Directors need to be able to make tough decisions, such as to let under-performing C-suite leaders go. For this, the board must have a readily available leadership pipeline.
This is typically more motivational for existing employees and a lower cost option compared to seeking external recruits.
Second, the leadership needs to be open and transparent. Some countries already require companies to report on their gender pay gap. The gap between the top and bottom job levels could be next. The board should get on the front foot by understanding the current state of work and roles in the organisations. Ideally, directors should be prepared to communicate the reasons for the pay gap and explain pay policies in their organisations. This will demonstrate a coherent approach on why certain jobs are paid more than others (for example, the level of skills they require).
Third, ensure a system is in place to help people move up the organisation. Talent is key, and retaining the right talent is all the more important. The board should encourage professional development by demonstrating a clear career path that takes its employees to higher-paid roles. By identifying and developing the hard and soft skills the organisation needs, employee engagement levels will be raised. Filling more senior roles from within the organisation is a more cost-effective approach, and builds a stronger, loyal organisational culture.
Finally, it is critical to drive the right approach towards reward strategy at each level within the organisation. Misalignment of reward outcomes to business results can cause a significant disengagement especially around senior executive pay. The board and remuneration committee need to take a more proactive role when it comes to pay and governance decisions. The debate over executive pay will increasingly come under scrutiny from shareholders and watchdogs alike.
By building a leadership pipeline, organisations can deliver enhanced engagement and reduce cost of replacements, hence reducing excessive rewards in the absence of market leading business outcomes.
This article first appeared in the Q1 2020 issue of the SID Directors Bulletin published by the Singapore Institute of Directors.