Outsourcing low paid work disguises true extent of growing inequality

The emerging data shows that the current regulations are deeply flawed.
- Professor Sandy Pepper
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Average CEO pay in FTSE 100 firms has escalated from £960,000 to £4million in 15 years, dramatically increasing inequality between senior executives and ordinary employees, according to new research from the London School of Economics and Political Science. However, researchers say the real pay gap is actually much bigger due to the ease with which firms can outsource low paid work to “manipulate” the figures.

Paul Willman, Emeritus Professor of Management, and Alexander Pepper, Professor of Management Practice, examined the changes inside firms that have accompanied increasing income inequality which they say has “become a matter of public and government concern”. They trace the growth in inequality to changes in the processes of determination of pay, describing it as a move from “administered” to “outsourced” inequality. Until the early 1980s, internal company processes defined pay: CEOs were paid salaries according to internal job evaluation processes, and the existence of strong unions and collective bargaining compressed the pay gap with ordinary employees. Since the late 1980s, CEO pay has become dominated by external market forces with the growth in stock-based reward packages. This has also been accompanied by the decline of unions and collective bargaining, and the outsourcing of low paid work.

The UK is widely regarded in Europe as having led the way when it comes to the disclosure of executive pay. This has been required for over 25 years and is now included in a directors’ remuneration report. The researchers charted the rise in FTSE 100 CEO pay from £962,145 in 2000 to £4,052,000 in 2015, an average annual change of 10.94 per cent and a total change of 172.49 per cent.

They then compared the ratio of average CEO to average pay for FTSE 100 companies from 2000 to 2015. The data excluded pure investment companies; in addition, the advertising and public relations company, WPP plc, has been excluded because of the distorting effect of the “staggeringly high pay” of its CEO, Martin Sorrell - £70.4 million in 2015. The average pay ratio varied substantially from 294 in Manufacturing (food, beverages and tobacco) where average staff pay is £28,000 compared to £7.6 million for CEO pay, to Real Estate where average staff pay is £58,703, compare to average CEO pay of £3 million.

By 2015, most CEOS of FTSE 100 companies were on substantially leveraged stock based reward packages but, the researchers noted, this variance in internal pay ratios is unlikely to be explained by variance in the value of such packages.

The paper notes: “The most obvious point to make here the ease with which firms may manipulate the figures on intra-firm inequality that can be calculated from publicly available data in the UK. There are in fact at least two possibilities. The first is to outsource low paid work. Many of the industries in the top half of the table certainly do so. Those in the bottom half of the table, for example in general retailing, find it harder to do so and contain many employees paid at or close to the National Minimum Wage. The second is to reduce the executive compensation figures, either those that are paid or those that are published.

It adds: “For the 94 non-investment companies in the FTSE 100, average pay in 2015 stood at £52,233. This is high – it is more than twice UK average earnings in 2015. It is consistent with the proposition that many firms on the list outsource low-paid activities, and thus they disappear from the calculations possible from public data. Outsourcing non-core activities in this way has become standard operational practice which the capital markets welcome as value-enhancing. Conveniently, of course, it also helps to disguise intra-firm inequality by shifting the legal boundaries of the firm. These UK examples are probably not extreme – it is almost certain that any measure of similar multiples for the Apple or Nike global supply chain would be much broader than one confined to Apple or Nike employees.”

It concludes: “Regulation or even effective normative pressures on such inequality measures may be compromised by the ease with which firms may outsource low pay. Compliance with any guideline or requirement may be dealt with by firms not reducing inequality but by moving organisational boundaries. The sectoral data suggest the ability to do this may vary between firms and sectors. In some cases, understanding the extent of inequality manufactured by a firm may require the examination of the entire global supply chain.”

Professor Willman and Professor Pepper commented: “Our paper is published as large UK companies start to publish pay ratios with their annual reports, but the emerging data shows that the current regulations are deeply flawed. They should really include all workers, including agency and other casual workers, as well as non-UK employees. Only then might these new disclosure requirements begin to have an effect.”

The role played by large firms in generating income inequality: UK FTSE 100 pay practices in the late 20th and early 21st centuries is published in the latest edition of Economy and Society.

It was funded by LSE’s International Inequalities Institute.