The Dangers of Pay Caps

By Jeremy Hutton, Policy Analyst.


On Tuesday the Labour Party released a report on how to tackle excessive executive pay. It recommends a number of key reforms to curb salaries at large companies (any company with more than 250 employees) that its authors would dub disproportionately high. Yet there are five in particular that the Shadow Chancellor and Shadow Business Secretary are reported to be keen on. These are:

  1. That large companies would be forced to publish the remuneration contracts of executives earning over £150,000
  2. That forms of remuneration such as share rewards be outlawed because they ‘invite abuse’
  3. Not only should companies publish their gender pay gap, but they should publish an ethnicity pay gap and specify the differential with employees at executive levels
  4. All stakeholders (crucially, not shareholders) of companies should gain the right to propose caps on pay and bonuses
  5. Company executives should be subject to an annual vote on their remuneration by stakeholders

So what’s wrong with these proposals?

Whilst all of the individual proposals under consideration by the Labour front bench contain numerous problems, these issues pale in comparison to the greater purpose behind the report. The motive behind forcing large companies to publicise all earnings over £150,000 is to embarrass those companies into simply not paying anyone over that level, or too far beyond it. If companies kneel to this and limit pay to this arbitrary figure, the effect would be harmful on two levels. First of all, it establishes a clear ceiling of ambition for mid-level individuals, meaning that once a certain level in their career is reached, either they seek advancement abroad, or are otherwise headhunted by companies in countries who are less anti-business.

Secondly, attempts to force large companies to limit pay so severely and making them slaves to their stakeholders will simply reduce the incentive for a smaller company to expand within the UK. This means that either British businesses become satisfied with second best and become mired in complacency and a ‘that’ll do’ attitude, or the temptation to shift expansion abroad grows.

But the intention to limit pay is damaging regardless of motive. To seriously consider publishing not just the remuneration, but the contracts of high earners represents a gross abuse of privacy. Employment and remuneration contracts are purposefully private items tailored to each individual’s needs. All that can be accomplished by forcing the publication of such documents is the creation of tensions between different levels of employee and potentially even fear of advancement. At its worst however, this incentivises the return of ‘gentleman’s agreements’ and the likely corruption and skulduggery that can accompany such an approach.

Meanwhile the claim that rewarding employees with shares invites abuse is fundamentally incorrect. By rewarding successful individuals with a portion of the business, you are increasing their motivation to succeed by giving them a long-term stake in the business. Offering cash rewards, as this report advises, merely incentivises mercenary behaviour based on short term gains rather than future success.

The ethnicity/gender pay gap proposals meanwhile are no better. This method of data analysis oversimplifies data and forces the exclusion of a range of factors relevant to the argument. As the Adam Smith Institute pointed out in October, there are factors that such simplification excludes which turn the argument on its head, such as the difference in median age between different ethnicities. As the ASI makes clear, something as complex as pay dispersal cannot be adequately explained by a form of measurement as crude as the pay gap.

But the maddest element of these proposals, is the granting of voting rights to stakeholders. A shareholder is anyone who owns shares, a proportion of the business. A stakeholder meanwhile is anyone with a stake in the company, i.e. every shareholder, customer and employee. This measurement can however be extended further still and is also dependent upon ones definition of a customer. Should one consider the suppliers of a company as a customer? Do outsourced employees get a vote? And then consider the bureaucratic machine necessary to hold any such vote and verify who qualifies for this form of suffrage. Any such system would be open to abuse. Imagine how Brenda from Bristol would feel should she be forced to vote for every large company she is a customer of?  Not another one indeed! The only individuals who would maintain the will to vote in these would be those with some form of petty motivation to harm those doing better than themselves.

It’s hard to see how any sane politician could seriously consider such damaging measures. Ones that would deepen tensions between levels of employee, de-incentivise growth and hold businesses ransom to a small proportion of activist stakeholders. But then, it’s equally as hard to see how any sane politician could seriously back McDonnell's communism as a form of government…