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27 August 2020

PwC’s magic wage gap wand

A shorter version of this article was published today in the Financial Mail.

In one fell swoop, PwC appears to have eliminated South Africa’s socially destabilising wage gap. The firm’s recently released Practices and Remuneration Trends Report – Executive Directors analyses publicly available information on executive remuneration at JSE-listed companies for the period 1 May 2019 to 29 February 2020.

PwC concludes that the median pay of a JSE CEO is only 18 times that of a semi-skilled employee, and 24 times that of an unskilled employee. The gap between CEO pay and the national minimum wage (acknowledged by PwC to be insufficient to support a decent standard of living) is presented as a rather reasonable 66 times.

How does PwC achieve this feat of making the wage gap look relatively acceptable, in a country which the World Bank considers to have the highest income inequality in the world? It uses only total guaranteed pay (TGP) as its base for comparison, and ignores by far the most significant components of executive pay, short and long-term incentives.

According to PwC’s latest figures, the overall median TGP for a JSE CEO is R5.2 million, which reduces to R2.8 million after tax. The semi-skilled median wage (according to PwC salary surveys) is R200 388 per annum, which reduces to R164 318 after tax; the unskilled median wage (according to PwC salary surveys) is R146 832 reducing to R120 402 after tax; and the national minimum wage is R43 596 which is not taxed as it falls below the R83 100 tax threshold. This gives PwC its ratios of CEO pay as 18, 24 and 66 times that of these three pay categories respectively.

It is hugely problematic to represent TGP as a realistic figure for comparison purposes. The general rule of thumb is that TGP represents around 1/3 of the total value of a CEO’s remuneration package, with short and long-term incentives each making up an additional third. Even this sometimes overstates the value of TGP, but on average PwC has made around two thirds of CEO pay disappear. Pay gap surveys in other parts of the world do not use TGP as the basis for comparison. PwC itself strangely compares SA’s pay gap to the “CEO to average worker pay ratios” in the USA and the UK (287:1 and 117:1 respectively), which are based on total pay, not just guaranteed pay.

To illustrate the problematic nature of PWC’s approach, consider SA’s most extreme example, Naspers. Using PwC’s approach, CEO Bob van Dijk’s remuneration for the year to March 2020 is R23.46m, his total guaranteed pay. The additional R252 million that Van Dijk received in short and long-term share-based incentives and “other benefits” simply doesn’t count.

All of PwC’s figures are comfortably below the 200-times-plus gap commonly assumed to exist between the CEOs of SA’s listed companies and its lowest paid employees. The ‘PwC gaps’ between CEOs and skilled and semi-skilled are also in line with an “ideal” figure cited by PwC in its report – “The classic, and oft-cited ‘ideal CEO to average worker ratio’ is a ratio of 20:1 (or 25:1), as advocated by Peter Drucker.”

PwC explains that Drucker, who is considered to be the father of modern management theory, advocated this ratio in the 1980s, and that while it might be considered dated, it continues to be cited in academic papers and articles as an ideal target. “Drucker provided early warnings on the dangers of enriching executives and argued that exceeding a ratio of 20:1 would result in an increased feeling of resentment among employees and overall, decreased employee morale.”

Although a recent study by the Harvard Business School concluded that Americans now believe an even tighter 7:1 is a more appropriate ratio, the past 40 years have seen the remuneration trend veer precipitously away from Drucker’s ideal. The current ratio at an average US-listed company is a stratospherically high 287:1. Things in the UK are significantly better with an average ratio of 117:1, but still dangerously above the ideal set out by Drucker decades ago.

PwC does acknowledge that the US and UK ratios are based on the CEOs’ total pay, which includes all the short and long-term incentives that are added to total guaranteed pay. Evidently no-one in the US or UK thought to apply PwC’s thinking to the problem. Or perhaps PwC’s US and UK partners reckoned the South African perspective would be rejected out of hand.

In addition to the problematic restriction of CEO pay to guaranteed pay, PwC’s analysis also takes place in the absence of half of the information required to reach an evidence-based conclusion. JSE-listed companies do not publicly disclose information about the wage gap between their lowest and highest paid workers, the most relevant information for assessing wage inequality.

At Naspers’ AGM on 20 August, Just Share asked how shareholders can make informed decisions about the fairness of executive pay in the absence of any information in Naspers’ (44 page) remuneration report about the pay of any of its South African-based employees. Koos Bekker’s brief initial response was that food delivery drivers in Denmark and India earn “completely unrelated packages” and that it is a “very vibrant world”. Somewhat more helpfully, “Chief People Officer” Aileen O’Toole responded that Naspers “absolutely agrees that societal fairness is a really important element in our pay practices and something that we take very seriously”, and committed to reviewing disclosures on wage gaps next year.

PwC doesn’t totally ignore the importance and value of incentives: it notes that “STIs and LTIs form a significant part of a CEO’s total remuneration”. But it goes on to explain that these variable incentives are used to reward successful strategy. “It is extremely difficult to compare variable pay levels to fixed pay levels, as the nature of ‘pay-for-performance’ is associated with a risk-return strategy, and should be highly variable based on the performance of an organisation.” Essentially PwC is excluding more than two-thirds of a CEOs remuneration on the grounds that measuring it is too complex. Ironically, this complexity is the creation of expensive remuneration consultants like PwC.

The “PwC wage gap” figures are a contrivance which appear to be setting the stage for the strong lobbying effort that will no doubt be directed at parliamentarians who will decide on proposed Companies Act amendments relating to disclosure of wage gaps. The disclosure of the wage gap is expected to fuel demands for executive pay restraint.

It is unfortunate that labour does not have access to the sort of expensive and powerful lobbying efforts available (for free) to protect executives who benefit so richly from the work of PwC and other remuneration consultants.

In the same report, PwC also appears to be preparing the way for executives to reap rewards from the Covid crisis. Far from encouraging executives to share some of the pain and suffering brought on by Covid 19 and the consequent lockdown, PwC describes a new category of post-Covid incentive: the “turnaround incentive”. “We have observed that several companies have been forced to contend with business interruptions and unprecedented loss of value. They are now navigating this uncertainty and re-strategising to determine methods that will allow them to recoup the lost values so as to keep the company afloat and avoid mass retrenchments.” To encourage them, says PwC, executives must be offered new forms of incentives that would pay out even if there were a drop (“short-term”) in profit and share price.

One can’t help feeling, when reading the PwC report, that its drafters have made some genuine attempts to understand wage inequality. But their own professional context renders them unable to come to any conclusion other than that executive pay levels in SA are just fine: after all, PwC itself has a “Rewards and Benefits” advisory division which advises many of these companies on how to structure their executive pay packages. Are they really the best people to be telling the rest of us what a fair wage gap is?