by NEI Investments.

We organized an investor working group to discuss ideas for narrowing the pay gap between top executives and everyday employees.

The challenge of reining in excessive CEO pay is a big one, but a group of concerned and influential players is taking steps toward solutions. NEI hosted a roundtable discussion in October with over a dozen participants, kicking off a shared effort to discuss what can be done to narrow the pay gap between top executives and everyday employees.

In a blog post we published near the end of this year’s proxy voting season, we asked, “How much is too much? How can the seemingly unstoppable increases in sky-high compensation packages be curbed? What are the best options for re-allocating executive pay?” Below are a few key themes and ideas that came up in tackling these questions and more in our workshop.

Capping pay would be a good start

Most participants felt that setting an absolute cap on executive compensation, regardless of the company’s financial performance, is something investors should push for. But everyone agreed the solution is challenging and could lead to unintended consequences, for example, if companies adjust workplace structures or manipulate data given how a cap would be calculated. One idea that came up is to focus efforts on improving internal pay equity and worker compensation and benefits, as opposed to a hard cap. Participants also suggested that asset managers could play a stronger role in advocating for unions.

The group agreed that say-on-pay, where companies ask investors to approve the compensation package for a company’s named executive officers, remains an underused tool. Most investors’ default vote is to support the form of pay packages, without using the vote to comment on concerns about the quantum of pay. (Say-on-pay votes are mandatory for listed companies in the U.S., but not in Canada.) The group acknowledged that integrating language related to pay disparity into voting guidelines is important as a way to determine how appropriate the ultimate amount awarded to executives is.

Vertical pay metrics are a useful tool

Most companies align their executive pay packages with industry peers, a practice known as horizontal benchmarking. A more equitable pay practice would be to align executive pay internally, against what others in the company are making. That’s vertical benchmarking. Our group considered CEO pay versus median worker pay to be the most useful vertical ratio, as opposed to, say, CEO pay versus lowest paid worker. The group also agreed it is worth using a three-way matrix: CEO pay versus executive pay versus median worker pay, to get a more complete picture of pay equity in the organization.

Despite some limitations with the median worker pay ratio, participants said it makes an excellent jumping off point for corporate engagement. It can lead to questions such as: How do boards use the ratio to set CEO compensation? Does the company plan to set a target ratio, and how would they go about meeting that target? How do employees feel about pay, given the ratio?

Changes to pay structure are required

 Executive salaries are often a very small portion of overall compensation, with the bulk of it typically tied to equity ownership and share price performance. However, since those components still tend to be pegged to salary, it may make sense to apply pressure to salary increases to help slow the increase in the overall package. Going further, a case could be made that executive compensation should revert to a structure that leans more toward base salary than equity awards.

Meanwhile, investors could push harder for the right to have a say on long-term incentive structures, with clearer disclosures and definitions. Equity-based pay could have longer vesting periods and include criteria linked to worker satisfaction or engagement.

It may also be worthwhile for investors to shift their focus to the other side of the equation, because it’s not just the highest levels of pay that require attention. It’s just as important to ensure the lowest pay levels in the organization are lifted up. This is where government can also play a role, by incentivizing companies to institute a living wage, for example, perhaps through tax breaks.

Next steps 

With our first working session behind us, the group is now moving ahead with identifying focus areas, and within those areas, some near-term action items. Potential focus areas include activating the power of say-on-pay, promoting a unified investor voice, and undertaking policy initiatives. We expect executive compensation to remain among the most significant ESG issues next year and beyond, and we look forward to collaborating with other investors as we move forward with solutions to benefit all stakeholders.