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February 2011

January 2011

Why the earnings gap is widening - and how you can stop it!

Have you ever wondered why the pay gap is widening? Let me show you.

According to the UK Office of National Statistics Annual Survey of Hours and Earnings the average earnings in 2010 were £26.500 and the average bonus was £1,020. Simple arithmetic therefore tells us that the average pre-bonus earnings would have bee £25,480 which means that the average bonus rate would have been 4%. 

There are no readily available figures for middle managers, but let us assume that your average middle manager earns twice the average basic wage. That would be £50,960. Let us then assume that the manager gets a 10% bonus. His earnings would then increase to £56,056.

Now let us look at executive pay.  According to Will Hutton the remuneration for FTSE 100 Chief Executives is 88 times the UK average wage. That would make the average CEO pay packet £2,332,000. I have no idea of the breakdown of those figures but based on a recent news report that the CEO of Lloyds TSB is getting a bonus of 225% on a salary of £1 million let's create a little table.

Let's be conservative and say then that the average base earnings for middle managers is double that at £50,960. And assume that the average CEO base salary was £1.1million and the average bonus rate was 112%. (Half that of the bank executive.) Then a table of earnings would thus look something like this:-

2010 Average Earnings 
Remember those averages include everyone in the workforce. That means they include the chief executives' earnings. Without those the averages for regular employees would be considerably less.  Also remember that the higher bonus percentage is against an already large base. It is no wonder the earnings gap is widening to such an alarming extent. It may also go a long way towards explaining why employee engagement is such an issue. And, furthermore, one that is unlikely to go away until this earnings disparity is addressed.

This problem is easily solved. You can see for yourself when you look at an equivalent table using my human asset valuation and labour dividend concept. 

2010 Average Earnings with labour dividend 
Obviously, the higher earners will lose out relative to their current incentives, but their rewards are still generous and not insignificant. In this example the chief executive's dividend is still more than twice the price of an average house. In any case the lower incentive will to some extent be compensated for by:-

  • The more equitable distribution; 
  • The greater consistency in the method of determination; 
  • The reduced need to justify the bonus;
  • Better results as a result of the greater team effort of the organisation as a whole.

It will also reinforce their need to increase their human asset value, and thus reinforce the whole model.

So that is how you can close the earnings gap. And at the same time create no-cost-employee ownership and address all you employee engagement problems and transform your bottom line results.  

How to create shared value

In a thought provoking article in the Jan-Feb 2011 issue of Harvard Business Review, Michael Porter and Mark Kramer claim that capitalism is under attack because business is "widely perceived to be prospering at the expense of the broader community." I don't think anyone in their right mind would challenge that statement.

Porter and Kramer argue that in neoclassical thinking a requirement for social improvement poses a constraint on the corporation and inevitably raises prices. The developing alternative is something they call "The Notion of Externalities." They explain externalities as social costs that business does not have to bear, such as pollution. Society imposes taxes, regulation and taxes to try to get companies to "internalise" these issues and change their behaviour: with similar results. (Actually a point I made in my book "A Feeling of Worth" albeit maybe not quite so succinctly.)

In what is an implicit argument against tax as an instrument of policy, Porter and Kramer talk about the concept of shared values. They claim that this recognises that "societal needs, not just conventional economic needs, define markets." They claim that rather than being a redistribution approach, "shared value is about expanding the total pool of economic and social value."

CSR 3 They argue that rather than making these social issues a cost this will impel companies to find solutions for them that will ultimately reduce those costs and thereby provide greater benefit for all. They say that "Companies must take the lead in bringing business and society back together." Since business is the primary consumer of economic resources, that certainly seems to be a valid statement that will help deliver "the new conception of capitalism" that is a pressing requirement right now!

They claim that a number of companies known for their hard-nosed approach to business are already leading the way in this regard. Maybe so, but it still seems to me that the start of "shared values" is the organisation itself. Thus employee ownership is not just a way of building employee engagement, but is a way of creating the shared values and hence the shared purpose that will make the organisation a community itself. That in turn will ensure it integrates better with the community at large. This ultimately will provide the motivation and the momentum to find the solutions that Porter and Kramer are talking about.

Don't you find it wonderfully ironic? The ideal way to create shared value is employee ownership that makes everyone an owner and that does not involve shares!  And do this and you may even help solve the world's problems.  

Widening Earnings Gap - A Growing Problem

Remuneration for FTSE 100 CEOs is now 88 times the median UK wage. (Source: Will Hutton Fair Pay Commission .) This has grown from 48 times ten years ago. This is a problem.

Unfortunately, there is not yet wide enough recognition of that fact.  Does any individual justify earnings so much greater than the rest of the people in his organisation? After all, an organisation is a collection of people who together enable it to fulfil its purpose. Nothing is possible without their combined efforts. Success or failure then is a collective achievement.

Now of course nobody is saying that they contribute equally. Some have greater skills and so make a greater contribution than others. The CEO is certainly one of those. You rightly recognise that by paying them more. But is an 88 times earnings differential really justified?

Think for a moment about BP. Tony Haywood was one of those CEOs. Yet he was not directly responsible for losing BP nearly $20 billion (and that is before any possible legal damages arising from the lawsuit.) As far as any one person can be held responsible it would the middle manager who failed to take the appropriate action on a rig that was known to have problems. Perhaps this is an extreme case, but my point is that while any CEO shapes the culture he alone does not determine events. Others daily make decisions that may have far more far-reaching consequences than any he makes. Decisions that can make or break the organisation. Decisions that can affect thousands (or in the BP case, millions.) Decisions that can cost lives. Yet those people might not even be very high up the organisational hierarchy. And they might not even be earning much more than minimum wage.

A competitive world, where speed of response is everything, pushes decisions further down the line. Surely then the earnings differential should be going down and not up?

Wage inequality These same executives even profess that they cannot do anything without their people. Yet they cannot seem to understand that this earnings gap is one reason why employee engagement is deteriorating. The picture explains why!

In all honesty, how can CEOs justify their remuneration?

The truth is executive remuneration has become a competitive field in its own right. And that competition has caused salaries to skyrocket. And in the process common sense has flown out of the window. This cannot continue. It is time to find a new process that is more equitable. That way they can still be paid more, but in line with everyone else. Employee ownership would ensure this, while also cementing employee engagement that ensures success.

A Small Step in the Right Direction

Small Steps HR Magazine has recently published research data from Towers Watson indicating that senior managers earned 35% of their base pay in bonuses and shares in 2009 compared to 45% in 2008. This certainly seems like a step in the right direction, but is it the start of a trend?

It will be interesting to see what the figure is for 2010. It is a pity we will have to wait almost a year to find out.

However, the really disturbing aspect of the report is that for middle managers the comparative bonus percentages were 13% and 16% respectively, compared to a constant 10% for lower level employees. It is no wonder that there has been a widening gap between the rich and the poor with the rich getting richer while the poor get poorer.

Hoefully the trend will continue. But I would not count on it. Few are challenging this disparity or the inequity of it. Least of all the HR profession. To see what this means you just have to look at the following comparisons:-

  Average worker pay - say £20,000 p.a.  - Bonus £2,000
  Average middle manager pay - say £40,000 p.a. - Bonus £5,200
  Average executive pay - say £1,740,000 p.a. - Bonus £626,400 (based on research that executive pay is currently 87 times the average worker wage).

It is no wonder the employee engagement is a problem. Encouraging workers to be more productive is, in their eyes, nothing more than self-interest on the part of their bosses to make them better off.

There is nothing inherently wrong in sharing profits among the people without whom they would not be possible. But surely the distribution rate should be the same. After all the different capabilities and thus presumably the value of the different contributions is already recognised in the base salaries. At 10% the executive bonus would still be a not too shabby £174,000 or the price of an average house.

Consequently I would suggest that, if you are going to insist on paying bonuses, you should ensure you use a standard bonus percentage rate applied throughout the organisation. Even better though is the idea of employee ownership with a labour dividend, which dispenses with the idea of a bonus altogether and instead shares profits equally amongst employee owners. That would:

  •   Ensure better value for the payroll spend
  •   Eliminate the manipulation of performance measures to safeguard earnings
  •   Ensure there is no unmerited payment when results do not justify it
  •   Likely guarantee more consistent results over time
  •   Do more than any other single action to maximise employee engagement.

It would be another small step in the right direction for man, but a large one for mankind.

Why it is time to kill the bonus

Noose Today's the day the new regulations governing bankers' bonuses comes into effect. From today, only 20–30% of bonuses can be paid in cash upfront, and under the Basel III rules, any banker working for an international bank must be rated on a ‘scorecard’ by their employer to justify their bonus.

So what difference is this going to make? I have written previously on how the bankers are getting round this provision and you may think I am picking on bankers. I am not.

It is simply that the whole issue of bonuses has been ill-conceived and even more badly handled. It really is time we dispensed with them altogether.

If you haven't already seen why we should not be paying bonuses, then I urge you to look at this video. I cannot think of a stronger case for dispensing with bonuses. Unless perhaps it is the report in "The Times" yesterday that the Finance Director of TUI travel received his share of a £4.9 million payout (£757,000) only weeks after being forced to step down over a £117 million accounting error! Needless to say the error was not in the company's favour. 

If that does not support my argument that the bonus culture has got entirely out of hand then I don't know what does. Here you have a man who is ultimately accountable for the presentation of the figures in the accounts; figures which have subsequently been proved to be wrong, and yet he still gets his bonus. Truly it is a world gone mad! And the bonus culture does not help.

Only getting 20-30% of your bonus is more than sufficient if you know there is no downside and the amounts are significant, which for banking executives they are. A system of employee ownership along the lines I propose, with "labour dividend" payments replacing bonuses would certainly be more effective. At least it would ensure that there is some sort of penalty for such errors in the form of reduced profits in subsequent years. Unfortunately it would mean that everyone suffers, but at least the pain would be spread more equitably.

And who knows. Such spreading of pain might also invoke the creation of accountability consequences that are present lacking.