Obligations and opportunities to use and report pay ratios
Business, Energy and Industrial Strategy Committee corporate governance report (2017) recommends companies’ annual publication of pay ratios.
Local Government Association recommends local authorities publish their pay ratios at Pay Compare to improve their pay transparency in its latest 2015 guidance.
The Equality Trust Pay Tracker 2017 reports the pay ratios (highest to UK average wage and highest to National Living Wage and voluntary Living Wage) of FTSE 100 companies.
City of Portland, Oregon USA has voted for companies with higher pay ratios to pay more tax.
Recent years have seen an increase in obligation that UK employers use pay ratios (also known as pay multiples) when determining their pay policies. There are now also lots of opportunities for employers to use pay ratios to help explain their pay policies even when they don’t have to.
The UK Corporate Governance Code
The UK Corporate Governance Code requires ‘a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors’, with a supporting principle that remuneration committees ‘should also be sensitive to pay and employment conditions elsewhere in the group, especially when determining annual salary increases’. Pay ratios can help these employers to do this.
The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013
The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 require that the directors’ remuneration policy of large and medium-sized UK companies must contain a statement of consideration of employment conditions elsewhere in the company – and group where relevant. Specifically, this must set out ‘whether any remuneration comparison measurements were used and if so, what they were, and how that information was taken into account’. Such comparison measurements could include the use of pay ratios or similar.
Companies Act 2006
The Companies Act 2006 places general duties on directors to promote the success of the company for the benefit of its members as a whole and with regard to the interests of the company’s employees and the impact of the its operations on the community. Accordingly, company directors will no doubt wish to monitor the impact of excessive pay inequality on their employees and the wider community. Pay ratios can help them do this.
Localism Act 2011
From the financial year 2012/13, the Localism Act 2011 legally requires local authorities and certain other public bodies of England and Wales to annually publish pay details of their employees in a Pay Policy Statement. This statement must set out, amongst other things, their policies regarding:
- the remuneration of their chief officers,
- the remuneration of their lowest-paid employees, and
- the relationship between the remuneration of their chief officers and the remuneration of their employees who are not chief officers.
Pay ratios can help these employers meet this legal requirement.
Further guidance to help these authorities prepare and publish their Pay Policy Statements has been provided:
- Openness and accountability in local pay: Guidance under section 40 of the Localism Act (Department for Communities and Local Government)
- Openness and accountability in local pay: Guidance under section 40 of the Localism Act 2011 – Supplementary Guidance (Department for Communities and Local Government)
- Pay Accountability in local government in Wales (Welsh Government)
This guidance expects authorities to publish their Pay Policy Statements on their own websites in a timely manner and that it should be possible to find them easily, for example, by using a simple search on the authority’s website.
The local government transparency code (Department for Communities and Local Government) expects qualifying local authorities to include their pay multiple (pay ratio) in the data they should make public.
The code defines the pay multiple (pay ratio) as the ratio between the highest paid taxable earnings for the given year (including base salary, variable pay, bonuses, allowances and the cash value of any benefits-in-kind) and the median earnings figure of the whole of the authority’s workforce.
The Local Government Association (LGA) recommends local authorities publish their pay multiples (pay ratios) at our free and public Pay Compare website – www.paycompare.org.uk – to increase transparency.
Government Financial Reporting
In its guidance to those handling public funds, the Government has required the reporting of pay multiples (pay ratios) since the financial year 2011/12. The current guidance – the Government Financial Reporting Manual (FReM) – states:
The median remuneration of the reporting entity’s staff and the ratio between this and the mid-point of the banded remuneration of the highest paid director shall be disclosed, whether or not this is the Accounting Officer or Chief Executive. The calculation is based on the full-time equivalent staff of the reporting entity at the reporting period end date on an annualised basis. For departments, the calculation should exclude arm’s length bodies within the consolidation boundary. Entities shall disclose information explaining the calculation, including the causes of significant variances where applicable.
The National Health Service
The Department of Health Manual for Accounts (MFA) sets the accounting policies to be followed by members of the Department’s consolidation group and provides principles based guidance to NHS bodies on how to prepare and complete their annual report and accounts. Reporting of pay multiples (pay ratios) by relevant bodies should then be expected given this manual states:
The MFA has been drafted to meet Government Financial Reporting Manual (FReM) requirements. The FReM is the technical accounting guide for the preparation of Departmental Accounts. The FReM follows IFRS and Companies Act requirements, but in several important areas interprets and adapts Standards to better meet Government’s reporting requirements. The FReM also details additional disclosures for the public sector. The MFA provides guidance that addresses the NHS’ requirements in more detail than the FReM, but readers must refer to both documents.
Since the financial year 2011/12, financial regulation of Monitor has required NHS Foundation Trusts to report their pay multiples (pay ratios):
The HM Treasury FReM requires disclosure of the median remuneration of the reporting entity’s staff and the ratio between this and the mid-point of the banded remuneration of the highest paid director … whether or not this is the Accounting Officer or Chief Executive. The calculation is based on full-time equivalent staff of the reporting entity at the reporting period end date on an annualised basis. Foundation trusts shall disclose information explaining the calculation, including the causes of significant variances where applicable.
The Government Financial Reporting Manual states:
In addition, the Welsh Assembly Government and the Department of Health, Social Services and Public Safety in Northern Ireland will apply the principles outlined in this Manual in the accounting guidance that they issue in respect of Local Health Boards in Wales, and Health and Social Services Trusts in Northern Ireland.
Independent Government Review into Fair Pay in the Public Sector
The Independent Government Review’s framework for fairness in senior public service pay recommends top to median pay multiples (pay ratios), where:
the pay multiple should therefore be calculated on the basis of all taxable earnings for the given year, including base salary, variable pay, bonuses, allowances and the cash value of any benefits-in-kind. The median earnings figure should be that of all employees of each organisation on a fixed date each year, usually coinciding with each organisation’s financial reporting year-end.
The Review further recommends:
Government should require that public bodies annually publish chief executive’s (or equivalent) earnings, median earnings of the organisation’s workforce, and the ratio between these two figures in their annual remuneration reports. All taxable earnings should be included within this multiple. Year-on-year movements in the chief executive’s earnings and median earnings should be disclosed and explained. Disclosures should begin in remuneration reports covering the financial year 2011-12, including prior year comparators.
- The Government, with advice from the Financial Reporting Advisory Board, should at the earliest opportunity amend the disclosure requirements in the Financial Reporting Manual (FReM) to require organisations to include the disclosures above, and should work with relevant bodies to make similar amendments to other relevant guidance including the NHS Manuals, the NHSFT FReM the IFRS based Code of Practice on Local Authority Accounting, and guidance for remuneration reports by NDPBs not covered by the FReM.
- The Government should encourage major suppliers to the public sector, and organisations that play a major role in delivering public services, but which are not subject to public sector financial reporting requirements, to include such disclosures on a voluntary basis, such that tracking and explaining senior pay in this way can become a norm across all public services.
- The framework of tracking multiples should be applied in the private sector.
- Over time norms for pay multiples should emerge within each sector (in health, in local government etc.), and citizens will be able to challenge outliers – those individual institutions whose pay multiples deviate significantly from those of comparable bodies within their particular sector.
Report of the Inquiry into Charity Senior Executive Pay by The National Council for Voluntary Organisations
The Report of the Inquiry into Charity Senior Executive Pay by The National Council for Voluntary Organisations recommends use of charity remuneration ratios (yet another name for pay ratios) to:
- help charities explain, within their remuneration statement, their approach to pay;
- benefit trustee boards and remuneration committees; and,
- assist in identifying and tracking the impact that differential pay policies and pay outcomes have on employees, their internal relationships and their lives.
The report specifically recommends that ‘charities with an income of above £500,000 consider the use of remuneration ratios (the multiple between the highest pay to median pay in an organisation is regarded as the most reliable measure) as a helpful tool to assist in their approach to pay; for example in helping to identify the impact of pay decisions on individuals and the appropriate distribution of any increase in payroll spend across the whole charity each year. Where charities choose to use such ratios, they should also use them to help explain, within their remuneration statement, their approach to pay’.
High Pay Centre Report: Pay Ratios – Just Do It
The Report on Pay Ratios by the High Pay Centre recommends that employers should use and disclose their pay ratios. The report opens in saying, ‘There is great value in identifying what the pay ratio is between the top and the median in a business or organisation … but we will only be able to track progress if pay ratios become a more prominent element in the continuing debate on pay and inequality’. It continues by observing, ‘A pay ratio is public recognition of the possibility that companies serve a purpose for employees and shareholders’ and that ‘a ratio expressing how fairly pay is shared would be one way of publicly recognising that companies should serve more than one purpose’. The report concludes, ‘Pay ratios offer companies the chance to demonstrate a practical commitment to consider pay elsewhere in the organisation by recognising that all employees’ pay belongs on the same spectrum’.
Chartered Institute of Personnel and Development report – The power and pitfalls of executive reward: A behavioural perspective
This report by the Chartered Institute of Personnel and Development (CIPD) finds that it is now time to re-evaluate the approach to executive pay. It finds chief executives are not being rewarded to do the right things in the right way and, particularly in the continuing aftermath of the financial crash, that rewards are seen to be unfairly distributed between all employees. The report calls for greater transparency and that organisations should be concerned with all the stakeholders and not just their shareholders. The report recommends, ‘Pay ratios between senior organisational leaders and other employees should be published and subjected to transparency checks, publicising factors which may influence the size of the ratio’. It recognises, ‘This is likely to be challenging in practice, but has to to be met head on’.
Global developments in the use and reporting of pay ratios
The use and reporting of pay ratios is not just for the UK – there are developments happening worldwide!
In India, the Companies Act 2013 (s 197(15)) requires that ‘Every listed company shall disclose in the Board’s report, the ratio of the remuneration of each director to the median employee’s remuneration and such other details as may be prescribed’.
In the United States of America, further to the Dodd-Frank Wall Street Reform and Consumer Protection Act (s 953(b)), the Securities and Exchange Commission adopted a final rule that ‘requires a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees’.
Again in the United States of America, City of Portland in Oregon has voted for companies with higher pay ratios to pay more tax.
The Global Reporting Initiative
To achieve a Comprehensive level of Standard Disclosure in accordance with the Global Reporting Initiative (GRI) international sustainability reporting standard, at Disclosure G4-54 an employer must ‘Report the ratio of the annual total compensation for the organization’s highest-paid individual in each country of significant operations to the median annual total compensation for all employees (excluding the highest-paid individual) in the same country’.