Economic View: The Greenbury effect - is it pushing pay higher?

Could the Greenbury rules that force disclosure of the full details of pay at the top of Britain's corporate hierarchy be about to prompt another upward ratchet in boardroom earnings?

Some directors of large companies are already claiming that the latest crop of annual reports is encouraging rather than restraining pay rises, because they set out in such detail the remuneration packages of every director on the board.

A lot of people have assumed that complete transparency on pay would embarrass the fat cats out of existence and give new leverage to institutional shareholders to impose restraint on directors.

The contrary view is that there is no better way of making a long-serving and loyal executive director restless about his pay than constant publication of the details of the packages of people in comparable jobs in other companies. Many company reports now have half a dozen pages of details about executive rewards.

Furthermore, those who change jobs tend to increase their earnings faster than those who stay, which makes long-serving directors still more restless.

When annual reports published only the earnings of the chairman and the highest-paid director (whose name they were not obliged to disclose) there was much less information available for individual directors to make judgements about their positions on the pay ladder.

This could, of course, be yet another self-serving argument for putting the brakes on the Greenbury bandwagon. After all, a rearguard action by the Confederation of British Industry against disclosure of the full capital cost of funding directors' pensions seems to be on the point of succeeding. That could take the teeth out of a central Greenbury recommendation. On the other hand, there is evidence that greater circulation of information is already responsible for accelerating board- room pay increases.

Comparisons of earnings at the top are far from a new phenomenon. There was and still is a whole industry of remuneration specialists researching the going rate for senior jobs. They acted as consultants to the board, advising what executive directors should be paid.

Board remuneration committees assumed they must pay above the median salary for the job to attract and keep the best talent. Since most aimed for the same objective, the median automatically rose.

It is therefore hard to dismiss out of hand claims that the far greater degree of disclosure imposed after the Greenbury report could accelerate this process by ramming home for executives exactly what they and their competitors earn. The shop floor used to call such pay rises parity claims, and they were very destructive, especially in the motor industry. This trend towards more disclosure - and therefore a more open and liquid market in top executives - is helpful to those who justify high pay increases on the grounds that the rates are set by an open market for top talent.

Ignore the market rate and you lose you best people; make the market work better and more transparently and you have a respectable justification for paying the going rate, however high it may be.

In theory, a once-and-for-all improvement in the flow of information inside a marketplace ought to adjust the prices paid, as any broker will tell you. Unfortunately, pay tends to ratchet in one direction, which is upwards. There is little pressure to cut back the rewards of those who may be overpaid already, but there tends to be much less resistance to increases. Executive pay will adjust upwards not downwards.

If this is correct, we may not see many signs of Greenbury-inspired restraint when the results of the current executive pay round are analysed in detail later this year. Indeed, the Greenbury report has a built-in mechanism that could keep remuneration in the best-performing companies rising strongly for some years to come. Everybody seems to agree with the report's suggestion that it is a good idea to replace share options, notorious for rewarding directors for movements in the stock market rather than improvements in performance, with properly constructed long-term performance schemes maturing three or more years ahead.

The advantage of a well constructed long-term performance scheme is that it pays only on the basis of results. Most institutional shareholders are perfectly happy with big pay rises on the boards of the companies they own if directors' performance is seen to justify them.

But when those schemes pay out, some will make recent awards look modest. Will the rest of the body politic, and especially a Labour cabinet looking for reforms of corporate governance and perhaps higher top marginal tax rates, have the same understanding as fund managers?

ICI set up a performance-related long-term scheme for Sir Ronnie Hampel, its chairman, in 1993, well before the Greenbury report was thought of. It came to fruition last year with a pounds 425,000 payment, so Sir Ronnie took home 42 per cent more than a year earlier, although his basic salary dropped as he changed from chief executive to chairman.

As a performance reward, after a demerger of ICI, the overall package was perfectly acceptable in Greenbury terms. But it looked bad in the headlines, particularly as Sir Ronnie is chairing the new corporate governance committee that will monitor the Greenbury rules.

Looking ahead, British Aerospace set up a long-term performance scheme, in accordance with Greenbury, while at the same time announcing modest single-figure pay rises for its directors this year. Assuming that BAe performs well, there could be some hefty rises in remuneration to report in a few years' time. Will this be another case of a long-term performance scheme that looks good at the start but attracts flak when it pays out?

There is hardly anybody, even among those on company boards most worried about the impact of the new levels of disclosure, who believes the clock should or could be put back. So if companies want to justify the rewards coming through from long-term incentive schemes over the next few years they will have to think rather carefully about how they implement and justify the schemes.

The performance criteria for long-term bonuses will have to be extremely demanding. Most of them are incomprehensible without an analyst and an actuary at your elbow, so ways will have to be found to make them more easily understood.

That may demand even greater levels of disclosure, with the annual report giving measurements of the directors' achievements to set alongside their bonuses, spelling out every detail of the reasons for the payment. Companies are in deep on disclosure, but will be forced still deeper.

Whether full disclosure turns Britain into a country in which high rewards for high performance are generally acceptable is another question altogether. We will see when those new long-term incentive schemes start paying out.