Tuesday, 22 October 2013

States Remuneration and the Ratchet Effect

There is a proposition being brought by Constable Philip Rondel for the States to reject the recommendation of the States Pay Review Body. If it is not rejected, pay for States members will increase by £600 - last year was £818.

If times were normal I am sure many of those who are against this rise would have no issue with politicians getting a pay rise just like everyone else. However we are in one of the worst financial crises in history. Many have had to suffer over the last few years with job losses, rising prices, wage freezes, pay cuts not forgetting government cut backs in services."

I imagine we can expect to hear "our hands are tied", "the board is independent",  And "I'll donate the increase..." All the usual explanations of why it should stand. Curiously, the issue of pay and sticking to the board's recommendations crosses ideological fault lines!

Now it is good that the board should be independent of the States, but it should also be representative of the Island, and I'm not convinced that it is. Ex-States members, ex-Chief Officers comprise the board, which is appointed by the States.

I'd like to see a few more working class people on the board. As it stands, they are all (as far as I can tell) retired or well-off, with  some on final salary pension schemes. None of them has any idea about what is happening in the real world, although the recent report about the economy shrinking might have given them an inkling.

Mr. Julian Rogers (Chairman)
Mr. Brian Bullock - ex Chief Officer
Mr. Maurice Dubras - ex States Member
Mr. John Mills C.B.E. - ex-Chief Officer

One of my correspondents has said - very topically - that it is "more 'shocking' for the want of a better word as to the lack of female members on the board. At a time where debate is being had on how to encourage more women into the States Assembly, I query as to whether the Assembly should be looking at writing into the Board's constitution a make up that is divided 50/50 between the genders."

And former Deputy Bob Hill has commented that: "I think it is right that the salary matter is not in Members hands. The problem is that the Pay Board's TOR are too narrow and awards are made in isolation and does not take account of the financial situation of the workers in the private and public sector. What is ironic is that States Members are prepared to accept recommendations when it comes to salary but not on States Reform."

The fact of the matter is that the recommendations are  marred by the composition of the board, who seem from their report to be out of touch with economic realities, and unrepresentative of the average worker (2 of the members at least are on final salary pensions as Chief Officers).

As a result, there is a "ratchet effect" not unlike that seen with the heads of large corporations in the UK, where comparisons are made among their own peer group, and not elsewhere. That is what is driving States members pay. They look at the most significant percentage rises and take that. They don't consider rises, for example, in median pay in the private sector.

They also fail to address the issue that 2%, for example, is much more significant to someone paid a higher salary than a lower one. The spread of pay across the public and private sector has also not been considered. There are no substantial analysis to back up their reasoning, weighing and balancing different measures; all that is done verbally, which can hardly be considered a firm foundation.

They say "while some employers may be anticipating an increase of, say, around 4%, others may still be contemplating no increase at all" but far from considering that perhaps no increase would be the way to go, they end up with an increase none the less.

In essence, they look at percentages, and while the board acknowledges that some private sector pay has been frozen, some is rising. They then take a percentage which will give a rising amount. That is certainly a ratchet effect bias.

That "ratchet effect" is something which is well known in studies of CEOs pay awards:

"In setting the pay of their CEOs, boards invariably reference the pay of the executives at other enterprises in similar industries and of similar size and complexity. In what is described as "competitive benchmarking", compensation levels are generally targeted to either the 50th, 75th, or 90th percentile. This process is alleged to provide an effective gauge of "market wages" which are necessary for executive retention. As we will describe, this conception of such a market was created purely by happenstance and based upon flawed assumptions, particularly the easy transferability of executive talent. Because of its uniform application across companies, the effects of structural flaws in its design significantly affect the level of executive compensation. "

"It has been observed in both the academic and professional communities that the practice of targeting the pay of executives to median or higher levels of the competitive benchmark will naturally create an upward bias and movement in total compensation amounts."

It's notable that the board has never recommended a complete freeze - as happened with the public sector a few years ago. They did recommend a year of freeze for States members in the basic remuneration, and - at the same time - increased the allowances also paid. As it is effectively all one pot of money - I'm not aware that any standing orders paying States members are split in any way - this means that there has never been an occasion when they have not effectively increased pay to States members. The word "effectively" is important, because they'll point to a few years ago when one component was frozen, and ignore the fact that the other was not. The "ratchet effect" leads to increases, even when there is an appearance of a pay freeze.

Meanwhile, in the private sector, and for the States employees a few years ago, there has been a freeze. The board is aware of that, but they say some wages have been frozen, some have gone up - and then they pick the going up as the way to go.

What studies have shown is that ratchet effect pay increases go by percentages and above the medians. I think that instead of looking at a percentage increase in average wage, as they seem to do as the basis for their calculation, they should look at the actual increase (not the percentage) in median wage. That would to my mind be a much fairer way of justifying any increase.

Consider this: if the median public sector wage has only gone up by £200, then why should States members expect more? It also provides an incentive for them to boost the economy.  Percentage rises favour those on higher scales of pay, so that the gap between the States members and the median wage gets larger.

Hence I would argue not that the States should not have an independent board, but that the board's results are significantly flawed, and the States should not just uncritically accept a flawed recommendation. That's the rejoinder to the "we must have independent pay" as an argument. If the pay review is badly flawed, should the States therefore accept it just because it is independent?

Let's hope people remember it is an election year next year! It's all very well to say "I won't accept it" this year, knowing full well that they have arranged an increase for future years just by changing their minds.


(1)   http://sites.udel.edu/wccg/files/2012/10/Executive-Superstars-Peer-Groups-and-Over-Compensation-10-10.pdf

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