Benchmarking of CEO Pay Questioned

Using peer groups to determine executive compensation leads to inflation, a study charges.

Peer Pay BenchmarkingExecutive compensation and how to determine it remains a hot issue. A recent survey by Institutional Shareholder Services (ISS) finds executive pay is the top governance issue cited by institutional investors in both North America and Europe. The issue ranks second after board independence in the Asia-Pacific region and developing markets. Meanwhile, a controversial research paper by the University of Delaware’s John L. Weinberg Center for Corporate Governance claims the standard board practice of using groups of similar companies as a benchmark to determine CEO compensation is unjustified and leads to escalating compensation levels.

Charles Elson, chair of the Weinberg Center and co-author of the study published in August, says the basic premise of using peer-group benchmarking is flawed. It’s not just that selecting the companies to include in a peer group invites manipulation of the results, Elson says. Nor is it that compensation is typically set at the 50th, 70th or 90th percentile found in the peer group, he says, though “that is like Prairie Home Companion saying, ‘All the children are above average.’ It leads to a ratcheting up of all CEO salaries.” 

“We find that companies use peer groups as one data point—an important data point for sure, but not the only one,” Lippincott says. “In many cases, they’ll use multiple peer groups—a narrow one of like-sized competitors, and a broader one. They also consider the state of the economy, overall employee compensation in the company and finally, performance. It’s not a knee-jerk, mechanistic approach.”

He says that while many companies and their boards are increasingly “diligent and thoughtful” about setting executive salaries in the wake of say-on-pay, they are doing an inadequate job on transparency and disclosure. 

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