With average pay increasing at about 2% and the impact of deflation, most workers should be starting to feel the squeeze on their wages easing. But at the same time, the gap between their earnings and executive pay is widening at a faster rate than ever.

The pay gap could be the bitterest aspect of the executive pay debate.

Data from the High Pay Centre says that executives are now paid around 131 times more than the average employee. With European legislation pending, boards and Remuneration Committees need to get to grips with disclosing and explaining the ratio between executive pay and average employee pay.

What’s driving the gap?

• Offshoring lower level roles to countries with a cheaper workforce. This reduces jobs available, increases competition and keeps pay down.
• Bigger roles for fewer executives. During the recession many senior jobs were cut. Those that remained got bigger with pay rises to match.
• The international market for senior roles drives up pay.
• There are a limited number of senior managers with the right skills. Demand for emotional intelligence, creative thinking and judgement is increasing as organisations change. Scarcity drives up pay.
• Only a fifth of executive pay is salary. The perceived value of the variable pay which is ‘at risk’ is lower so LTIP or bonus values are increased to make them attractive.
• Executive variable pay is often linked to Total Shareholder Return, so an increase the share price will have an impact on executive pay but not that of employees.
• Remuneration Committee’s redesign to incentivise. When variable pay schemes don’t pay out through difficult circumstance (rather than poor performance) the scheme is often redesigned so the impact of a failure to pay out is often short lived.

The impact on employee engagement:

Some argue that a wide pay gap provides an incentive to highfliers but there’s no evidence to substantiate that. The potential to cause discontent amongst employees is huge. Research from the University of Wisconsin shows that:

• When pay differentials are too large lower paid employees regard their pay as inadequate and react negatively, for example by withholding effort.
• Wide pay gaps harm company performance by damaging the quality of relationships and reducing collaboration
• Dysfunctional behaviours can develop such as retention of knowledge to create a pay advantage

A wide pay gap only positively impacts an organisation where it reflects individual performance: where executives are driving company performance to the benefit of all (through higher wages), high executive pay is regarded as merited.

What’s the right ratio?

It’s impossible to say as much depends upon the shape of your organisation and the types of employees you have. A company with large numbers of low paid employees such as a retailer will have a very different ratio to a professional services firm.

Year-on-year the ratios will change too as a result of company strategy, (redundancies across a strata of the organisation or sale / acquisition of a large employee population) or as a result of external factors such as scarcity of particular skills driving up market rates. The volatility of some aspects of executive pay will also have an impact.

So rather than just looking at the ratio as an independent factor, take a more holistic view of pay progression. Analyse the size of jobs and the pay associated with them to give you a view of internal equity. And ensure each level is aligned well with the market.

The pay gap has the potential to test the trust between executives and employees so regardless of any pending legislation, companies need to be transparent with employees and communicate why reward policies are in place, and how it affects them personally.