US investors drive growing top income inequality in Britain
New findings show that the Americanization of British firm ownership causes substantial increases in executive pay
Income inequality, and the increasing concentration of income and wealth at the top of the distribution, have become a major cause for concern in both scholarly and public debate. The share of income taken by the top one per cent in the UK has more than doubled between 1975 and 2014, from 6.1 to 13.9 per cent. What has been driving this worrying trend? Previous research has invoked factors such as the rising capital share, the growing political power of the wealthy, technological change, and financialization. In a new working paper we uncover another cause: the Americanization of the British economy.
While most previous research on top income inequality has worked with aggregate national-level data, our study proposes investigating the dynamics driving income gains at the top using fine-grained micro-level data on the elites that populate the ‘top 1%’. To do so, we retrieved detailed information on the remuneration of high-level managers at publically listed UK firms, which are disclosed in companies’ annual reports. We were able to collect this data for two to five high-level managers at several hundred UK companies each year between 2000 and 2014 (the size of our sample fluctuates between 670 and 980 companies per year). This grants us with a time-series panel dataset that ranges from 1,800 to 3,100 individual annual salary points. Altogether, the companies in our dataset cover roughly 40 percent of all UK-incorporated firms listed on the London Stock Exchange, making it fairly comprehensive.
Figure 1 presents descriptive statistics on the evolution of executive salaries in the UK, and compares them to concurrent developments in the USA. Three points are notable: (i) Executive salaries in the USA are extraordinarily high in cross-national perspective, with the median executive among large US firms taking home more than USD 10 million a year (samples are restricted to companies with at least 10,000 employees to improve comparability). (ii) Typical salary packages in the UK – although being one of the best-paying labour markets for managers worldwide – are still significantly smaller (note that sampling issues may affect the observed difference, but they are unlikely to account for a significant part of the large divide). (iii) Yet, at the same time, pay packages for British top managers are rising fast. The median pay in our UK sample more than tripled from 2000 to 2014, from USD 1 to 3 million per year. Equally interesting, the temporary decline in pay in the aftermath of the financial crisis seems negligible in the longer run, with median salaries consistently exceeding pre-crisis peaks since 2010.
Figure 1. The evolution of executive pay in the United States and United Kingdom, 2000-2014
SOURCE: Own calculations based on BoardEx data. NOTE: For better readability the y-axis is in logarithmic scale. Lines show the value of the annual salary of the median executive in the median firm in the country-sample. All values are in constant 2017 USD. To improve cross-country comparability, country samples are restricted to very large companies with at least 10,000 employees.
What has been driving the remarkable growth in pay for UK executives over the past two decades? To find out, we combined this detailed information on executive pay with data on the corporations that employ the managers in our dataset, and undertook a series of econometric analyses to uncover the statistical determinants of UK executives’ levels of pay. In line with previous studies, we found salaries to correlate with some individual characteristics (such as their connectedness, gender and age) as well as attributes of the companies they work for (such as their size, stock price and financial performance). Less obviously, our data reveals that who owns a company also matters a great deal. In particular, we found strong indications that salaries for British high-level managers increase as levels of corporate ownership by US-based investors grows. In our most restrictive models, each percentage point increase in the ownership of outstanding stock by a US-based investor is associated with a substantial 0.4 per cent increase in pay for top managers in British firms – a big deal in light of the rapid internationalization of corporate ownership in the UK over the past two decades.
To take into account potential endogeneity issues that may taint this empirical relationship, we performed additional difference-in-differences analyses in which we compare over-time trends in executive pay in British firms that become Americanized to similar firms that don’t. The results strongly confirm our findings: the Americanization of British firms causes substantial increases in executive pay.
Why would that be? A benign reason for these findings could be that the entry of US investors improves the performance of the firms they acquire, with increasing levels of pay merely reflecting greater profitability. However, testing for this possibility in our analyses, we found no indication whatsoever that the Americanization of British firms is associated with better financial results. So why are British executives paid more if US owners become more influential, even if financial performance stagnates? While we do not know for sure at this point, we do have some hunches. Two factors in particular seem important: on the one hand, the prominence of the shareholder value maxim in the US economy means that US investment funds are fervent advocates of ‘pay-for-performance’. The conviction that generous rewards will motivate high-level managers to do what’s in the interest of shareholders – i.e. to increase a company’s stock price – runs high on Wall Street. The expansion of US investors in the UK may have contributed to spreading the gospel on this side of the Atlantic as well. On the other hand, the entry of US owners in British firms can also trigger a range of benchmarking dynamics that result in upwards pressure on pay. For instance, Americanized firms are more likely to hire high-level managers with US experience who will ask for US-style levels of remuneration; US owners are more likely to appoint American remuneration consultants who will likely recommend US-style pay packages to shareholders and firms’ HR departments; and, not least, British executives in Americanized firms may suddenly feel empowered to compare themselves with their generously rewarded American peers in salary negotiations.
What does this mean and what can be done about it? What our findings highlight in a broader perspective is the extraordinary power and extraterritorial reach of US investors in a globalized economy, which contributes to the export of US business culture and practices to other jurisdictions. It is unlikely that many people in the UK will agree that eight-digit pay packages should become the norm on the London Stock Exchange. But pressures to move into this direction are strong and well under way. Yet, at the same time, it’s not all bad news. The substantial cross-national differences in executive pay per se demonstrate that politics in a broad sense really matter in setting levels of top income inequality. Public blaming and shaming in the media have been a powerful means in posing a cap on excessive pay in the past. Shareholders – including the pension funds we are invested in – vote every year on publically listed firms’ remuneration policies, empowering them to speak directly to management about these issues. And smart corporate governance reforms (such as imposing transparent, legally binding criteria on how executives’ salaries should be calculated) could undoubtedly do a lot to re-align incentives with the interests of society at large. The trouble is: neither the media, nor shareholders, nor the Government will act unless they are pressured to do so. Therefore, stopping these powerful trends towards an ever-growing redistribution of economic rents towards the top will require the public to take note – and action.
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