Flaws found in peer benchmarking of executive pay

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Peer groups might be the way major corporations attempt to ensure their executives’ pay “keeps up with the Joneses” but ongoing research by the University of Delaware’s Charles Elson and Craig Ferrere suggests an overreliance on peer group compensation benchmarks is a factor in what many see as excessive compensation for CEOs. At a panel “De-emphasizing Peer Groups — What’s Next?” held last week at UD, Ferrere, a 2011 UD graduate and recipient of the first Edgar Woolard Fellowship that spring, pointed out data that showed executives rarely leave to work for other companies.

 We looked at data on the CEOs from 1,500 companies over the last 20 years and in the entire database there were only 27 turnovers where CEOs were identified as moving from one company to another,” said Ferrere.

One of the greatest flaws of using peer groups then, said Elson, Edgar S. Woolard Jr. Chair in Corporate Governance, is the inherent reasoning that emphasizes this transferability of talent.

If executive talent is not transferable then the whole theoretic notion of the peer group collapses,” said Elson, who is also director of the John L. Weinberg Center for Corporate Governance. “The view is that CEOs can move somewhere else and there is a market for their talent, which is why we compare them, but it turns out when you become CEO that’s not necessarily true. Yes, there is movement for lower ranking officers but movement by the CEO position is very unique.”

Citing JCPenney’s recent management issues, Elson pointed out that CEOs do bring a number of skills to the table but those skills are not always transferable and do not equate to success in another company.

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Ferrere also explained that separating the pay scheme of the CEO from everyone else in the organization can create problems internally.

Two separate systems where a CEO is paid based on peers outside the company will create a disconnect over time within the organization and can act as a disincentive.”

Instead, Elson and Ferrere recommend an internal model that de-emphasizes the use of the peer group and focuses on internal performance metrics and the context of the organization.

While some panelists countered that peer groups are here to stay, many agreed that finding a better balance could help address the issue of inflated executive pay. – University of Delaware

 

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