The huge pay gap between public and private companies

BBC business editor Robert Peston on big business pay

The Institute of Directors has published its annual directors' rewards survey - and the results are possibly not what you would have expected.

The big finding is that the majority of directors across the private sector received a pay cut in real, inflation-adjusted terms in 2010: 46% of directors either had a pay freeze or pay reduction in cash terms in 2010; the 54% who had a pay rise received 2.5% in 2010, which is equivalent to a cut when inflation is taken into account.

Or to put it another way, the pay experience of the majority of private-sector directors is similar to the pay experience of most private-sector employees: there've been slimmish picking over the past year of economic recovery.

So how does that square with the recent authoritative report from Incomes Data Services, which disclosed that FTSE-100 directors saw their total earnings increased by a mouth-watering 55% on average over the past year, while the average increment for the FTSE 350 as a whole was 45%?

Surely the surveys are contradictory? How can it be that one survey shows that directors have almost never ever had it so good and another one shows that they're tightening their belts a notch?

Well the surveys looked at different groups of private-sector bosses.

The Institute of Directors analyses the pay and bonuses of more than 1,500 directors of large unlisted companies plus small and medium size enterprises (SMEs). Incomes Data Services trawls through the remuneration of substantial companies listed on the stock market.

What the two surveys have disclosed is a massive difference between what those at the top of big public companies receive, or companies that are largely owned by institutional investors, and the rewards of bosses of privately owned businesses, where those bosses are often the owners as well as the managers.

What could explain this stunning contrast between the FTSE-100 executive class and the owner-manager class?

A number of possible explanations suggest themselves.

One is that many smaller private companies continue to find business conditions challenging, either for want of demand for their goods or services or - more contentiously - for want of adequate supply of finance from the FTSE-100 banks.

Certainly, it's been relatively easy for big sprawling listed companies to cut costs and overheads to boost margins during the downturn, and thus to engineer a profits recovery during this mild economic recovery, whereas smaller companies that started with fewer employees and less fat have found it harder to increase efficiency.

Apart from anything else, big companies have the size and muscle to derive gains by forcing their suppliers to cut prices (as shown by the furore highlighted in yesterday's Telegraph over Serco's demand - now withdrawn - for a 2.5% rebate from its suppliers); smaller businesses lower down the food chain simply don't have that opportunity.

But it is also probable that what we're witnessing in the pay disparity is another manifestation of the agency problem: irrational decision-making at listed companies which stems from the gap at listed companies between owners and managers.

Let's make the assumption - which is largely born out by the economic data - that most private-sector companies, whether privately owned or publicly-listed, are enjoying some kind of recovery.

In those circumstances it may still be rational for directors of those companies to take only modest pay rises: it may be prudent to conserve as much cash as possible in the business, given that the outlook is uncertain; or it may be sensible to align the pay experience of those at the top with the pay experience of employees and the wider British workforce, to improve morale and foster cohesion in the workplace.

That may be blindingly obvious to those who own and manage businesses, because there's no escape for them from those businesses; their one chance for personal prosperity is the survival and growth of their respective companies over many years.

But chief executives on contract at FTSE-100 companies are in a different position; as hired guns, it is rational for them - if not necessarily for their companies - to pocket as much as possible as quickly as possible from pay, bonuses, share options and long-term incentive plans.

Which of course is why for the past 20-odd years there have been endless attempts, through corporate governance codes and remuneration reforms, to more closely align the interests of publicly-company bosses with owners.

Even so, the central discussion on most FTSE-100 remuneration committees, which set the pay of FTSE-100 bosses, is about what their respective companies have to pay their senior executives to prevent those senior executives defecting to rivals.

That means FTSE-100 pay is driven to a large extent by the dynamics of a so-called talent market, which seems to operate in a way that is semi-detached from the performance of the public companies themselves.

But if the market rate for FTSE-100 executives is a 54% pay rise, while more-or-less everyone else is seeing their pay reduced in real terms, then some are arguing that the market is an ass.

It would probably not be healthy for the economic prospects of the UK if most FTSE-100 companies suffered the kind of reputational damage from the way they pay their top people that has so harmed the public standing of our biggest banks as a result of the big bonuses they've been paying.

But since those who sit on remuneration committees are themselves beneficiaries of a pay system founded on the Rooney/Toure principle that the going rate is all that matters, it's not altogether surprising that the wider public interest does not seem to operate in boardroom negotiations on compensation.

Public companies have of course been put on warning about all this by the Business Secretary, Vince Cable, who has launched a sweeping corporate governance review that will take in the question of whether FTSE-100 executives pay is excessive.

Mr Cable will find it difficult to ignore the yawning remuneration gap between large public companies, which represent the immediate past of the British economy, and the smaller private businesses which the prime minister has identified again today as the UK's best hope for a prosperous future.‬‪

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

More on this story

Around the BBC