Memorandum from the Hay Group
This paper does not attempt to answer all the Select
Committee's questions—although we would be happy to do this—but
concentrates instead on a few observations and suggestions.
COMMENTS ON
EXECUTIVE PAY
IN THE
PUBLIC SECTOR
Committee Members, MPs and members of the public
are understandably concerned about the value for money they get
from public sector pay. We believe that the best way to improve
value for money is not to complain about specific salary levels
or bonus payments but to look at the market as a whole and concentrate
public and regulatory attention on a small number of practicable
reforms.
First, therefore, some comments about public sector
reward systems:
1. The Public Sector is not one market
Public sector organisations occupy a broad spectrum.
In practice they operate very differently and it will not help
them or the taxpayer to lump them all together. For example, the
Senior Civil Service is largely recruited from within the ranks
of public servants rather than in the open market. Unsurprisingly,
they have the lowest base salary levels of all main public services.
Local government offers higher salaries for jobs
of similar weight and challenge, but this is because chief executives,
directors and heads of service are recruited in the open market
across the UK. In addition, as the Audit Commission has noted,
pay has begun to reflect the performance of councils as measured
by Comprehensive Performance Assessment and there is a demand
for senior managers who have helped to improve local authorities
("Tougher at the Top?", Audit Commission discussion
document July 2008).
Universities recruit their Vice Chancellors
in the international market—mainly from other higher education
institutions—and they select the heads of business schools
from among international competitors and the private sector. The
pay of university heads has increased significantly in recent
years and heads of business schools receive more. In both higher
education and business schools, international measurement systems
are available which enable recruiters to identify people who are
associated with the best performing organisations, just like they
can in local government but this time on the international stage.
So even in the public sector, pay levels reflect
the openness of the market and the track record of the individual.
The point is underlined by experience in the Senior Civil Service,
which recruits a minority from the wider market. That minority
is paid around 20% more than those who have been promoted within
the service (Government Evidence to the Senior Salaries Review
Body, December 2008).
2. The sector includes a wide range of organisations
Policy towards the public sector in recent years
has created a spectrum of organisation types. In part, this spread
reflects the level of control from the centre of government, in
part the opportunity and responsibility to operate commercially.
For example, central departments and the agencies
which they fund are relatively closely controlled and are subject
to the standard Senior Civil Service pay arrangements. There are
various public bodies which have earned greater autonomy and are
more likely to determine their own pay arrangements at executive
level such as academy schools, foundation trust hospitals and
agencies operating as Trading Funds. Then at one further remove
from direct control are public corporations and government owned
companies, which determine pay themselves throughout their employment
structure. As public sector organisations become more independent
and commercial, they are more likely to operate in the open recruitment
market and to see a need to match wider market practice in salary
level and the configuration of the total employment package.
These differences are reflected in the NHS in
England. The directly managed part of the NHS including Strategic
Health Authorities, Ambulance Services and Primary Care Trusts—is
covered by the national framework for Very Senior Managers, which
is reviewed annually by the Senior Salaries Review Body. Provider
trusts which do not have foundation status set executive pay locally.
Foundation Trusts also set executive pay locally, have further
pay freedoms and certainly pay more than the Very Senior Manager
system, although their governance arrangements (including for
remuneration) are regulated independently by Monitor.
While the position in the NHS is a little confusing,
it makes sense to relate autonomy in setting pay to the acquisition
of other policy and commercial freedoms.
3. There is an overreaction against performance
related pay in all its forms
There is a long tradition of hostility in most
of the public sector both to linking salary progression to performance
and to the use of bonuses. The Senior Civil Service, senior jobs
in local government and the commercial public sector are exceptions,
but outside these groups it is often argued that linking performance
and pay does not suit the work and culture of the public sector.
Suspicion of performance related pay has grown recently
as a reaction to the bonus culture in City institutions and certain
banks and the combination of high bonus payments and obvious performance
failures. However, the investment banking sector is not typical
of how performance-related incentives operate in the private sector.
Just because a few organisations pay far too much for the wrong
things does not make the whole principle bad. In addition, in
spite of indications to the contrary from recent publicity, a
good system of bonuses and incentives takes care to encourage
people to do the basics well and then to achieve more on top.
It does not reward them for meeting a few targets while ignoring
the main features of the job.
Most important, it is only sensible to relate
rewards to performance. The alternative is to pay people the same
whether or not they perform—which is not even common sense,
let alone good use of public money.
The real difficulty with public sector pay is
that it is not sufficiently related to performance. The negotiated
pay systems covering the majority of public sector staff, generally
up to quite senior levels, are still dominated by incremental
pay structures which reward length of service and discourage effective
performance management. Some executive pay also bears little relationship
either to the performance of the organisation, or the top team
or the individual.
The most obvious example is the NHS, where many
top salaries are supposedly set based on market rate and little
use is made of bonus payments. The approach is exemplified by
the Remuneration Report from one of the country's largest Foundation
Trusts, which states: "No element of the executive directors'
remuneration is performance related". This cannot be right.
It is essential to provide a clear definition of good performance,
and executives should not continue to receive high salaries and
good increases unless they deliver the required performance.
Finally, insofar as public service has operated
performance-related, non-consolidated bonuses, these have tended
to be focused on individual rather than organisational performance.
As such they are much harder to justify to external stakeholders
than arrangements related to the value the organisation itself
delivers.
4. Stakeholders should have information but
not all public bodies provide it
There has also been debate about the right of
the public to clear information about the pay of executives in
the public service.
The clearest rules and practices of disclosure are
in the commercial public sector and the NHS, where top team salaries,
bonuses and pension entitlements are published—although
the salaries are often in bands rather than actual figures. There
is also a strong element of disclosure in: the Senior Civil Service
(where permanent secretaries' salaries are published and information
about the top 5,000 or so civil servants is released each year);
police forces, where salaries are set and publicised nationally;
and universities, which state the remuneration of the Vice Chancellor
and list other senior salaries in bands.
The exception among major organisations is local
authorities. They do not generally publish annual accounts in
a format which members of the public can obtain and understand,
nor do they disclose the remuneration of the top team. Most public
information about executive pay in local government comes from
press articles and freedom of information requests by individuals
and lobby groups.
It is arguable that all organisations funded
by the public should have a common duty to disclose executive
remuneration at least to the standard required of a PLC. At very
least, there should be a duty placed on local councils to make
available the remuneration of the chief executive and directors.
Whilst there is some evidence that pay disclosure
creates pressure for pay increases from executives, there is also
strong evidence (from both the public and private sectors) that
transparency improves the decision making of remuneration committees.
On balance pay disclosures are of net benefit to the setting of
appropriate pay packages, even leaving aside the governance arguments
for such disclosures.
5. Remuneration Committees should consider
the terms and conditions of senior executives
Many public sector bodies have—or are
working towards—single sets of terms and conditions that
apply across the whole workforce. Whilst "single status"
is a useful principle for the wider employee population, it is
debatable whether this approach should apply at top executive
level. In our view, senior executives should be employed on service
contracts with terms and conditions that are appropriate to their
roles and which reflect the significant pay they receive. As a
specific example, it is inappropriate for senior executives to
be eligible for generous redundancy payments.
6. Pensions are a separate issue
In recent years, the private sector has moved away
from final salary pension schemes because their cost is unsustainable.
Whilst a proportion of longer-serving private sector executives
are still in final salary schemes, some companies are looking
to end even these legacy entitlements—a process that is
likely to be accelerated by the changes to pensions taxation set
out in the 2009 Budget.
Meanwhile, although there have been changes in entitlements,
the major public sector schemes still offer final salary or at
least (for new joiners) salary average schemes, with index linking
and at modest employee contribution rates. The cost of many schemes
has been pushed-up by above inflation salary growth in parts of
the public sector and the tendency to target pay increases into
consolidated salary. For a long-server the pension costs of any
salary increase will far outweigh the value of the salary increase
itself.
There has already been public and media comment
on the gap between public and private sector pensions and disquiet
on this point can be expected to grow. We believe that this point
should be separated from concerns about pay and given proper attention
in its own right. Public sector pay is not necessarily too high
but simply too detached from performance. But the public sector
pension bill is extremely high and, sooner or later, the gap between
different parts of the economy will have to be reduced.
However, we would note that the pension gap
between public and private sector is much less evident at senior
levels. This reflects the private sector practice of providing
proportionally higher pension benefits to senior executives.
Suggestions on public sector pensions policy
go beyond the scope of the Committee's inquiry and we therefore
do not include any below. However we would observe that a potential
solution that might be acceptable to all stakeholders would be
as follows:
— insofar as public sector pension provision
continues to be linked to final or average salary, these arrangements
should be capped at a given level of salary (say, £30,000);
and
— provision on the slice of earnings above
this level should be on a defined contribution basis.
SUGGESTIONS
Our suggestions are simple:
(a) There should be no attempt at greater intervention
in the public sector market, diverse as it is or at capping the
salaries of particular groups. This will simply constrain rewards
for specific organisations and limit their access to talent.
(b) The regulatory framework for executive pay in
the public sector should concentrate on three areas:
— The requirement for a full and published
policy on executive remuneration and a clear process for setting
and reviewing it, overseen by a properly constituted, trained
and advised Remuneration Committee.
— A consistent requirement for disclosure
of executive remuneration which applies throughout the public
sector (ie organisations which are wholly or mainly funded by
direct or indirect public grant). This requirement should include
local authorities. As part of this requirement, the practice of
disclosing salaries in £5,000 bands should be replaced with
disclosure to the nearest £1,000 in line with private sector
practice.
— A duty on Remuneration Committees to
relate pay to performance (of the organisation, team or individual,
as appropriate) and to explain in their policy statement how this
link works.
(c) Where public sector executives receive pay
and benefits that are competitive in the wider external market,
their terms and conditions of employment should also reflect conditions
in the external market.
May 2009
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