Is the compensation package competitive? The answer to this compensation question asked by every executive is “it depends”.
In order to determine whether the compensation package being offered by the prospective employer is competitive, most executives, recruiters and pay consultants turn to industry peer review compensation data. This process is called benchmarking and it involves gathering compensation data from publicly owned companies within the same industry and revenue group. The information is collected from corporate proxy statements and other filings with the Securities and Exchange Commission. Our firm uses the ecomponline.com database, a division of Aon Consulting, to gather industry peer review data for compensation analysis.
Proponents of benchmarking argue that the data represents the current competitive market information on compensation pay. Underlying this data is the presumption that if the market is competitive and working efficiently, than pay is commensurate with performance. This view is often called the “optimal contracting” approach. Opponents of this theory, continue to argue that benchmarking data is easily manipulated by the originator of the research to create a favorable outcome. Opponents critically accuse incumbent executives of manipulating the data to extract rents from fellow board members in the form of excessive compensation. More importantly, the benchmarking process has the direct effect of inflating overall compensation levels across every industry. Some argue this is the “compensation bubble” that has yet to burst. Thus, weak performers can still expect to receive competitive compensation packages, even though shareholder value continues to diminish.
Further complicating the issue of competitive compensation pay is the adverse impact of conflicts of interest among board members on compensation committees. The New York Times reported on December 18, 2002, that:
“an examination of almost 2,000 corporations finds that at hundreds of them, members of the compensation committee work for or do business with the company of its chief executive. In some cases, they even belong to the executive’s family. . . The study by the New York Times of almost 2,000 of the largest American corporations, measured by their stock market value, shows that 420 of them, more than 20 percent, had compensation committees in 2001 with members who had business ties or other relationships with the chief executive or the company that could compromise their independence. Dozens of those members were company executives. At more than 70 companies, even the chairman of the compensation committee had such ties, and in nine cases the chairman was actually an executive of the company. These are just the connections that have been fully disclosed to investors.”
Although newly proposed rules have been issued, conflicts among directors will continue to exist and compensation packages will arguably continue to increase. Executive compensation continues to be controlled by the non-economic political and institutional variables that distort the decision calculus followed by compensation committees. Many compensation committees have been criticized for “rubber stamping” proposed executive compensation plans and individual pay packages. For example, Tom Wyman, former CEO of CBS and former member of other corporate boards, was recently asked how long his boards took to consider the pay package of the CEO. Wyman responded, “maybe ten minutes or less.” NewsHour with Jim Lehrer, December 2, 2002.
The evaluation of performance pay is also grounded in the industry peer review analysis and benchmarking process. Companies often indicate in proxy statements that performance compensation, “[was] set to be competitive with the median of such targets for executives in similar positions at the major oils and in the comparison group.” Amoco 1997 Proxy Statement, at p. 20. Scientific Atlanta’s 2002 proxy statement provides, “At the beginning of fiscal year 2002, Mr. McDonald’s base salary was increased to maintain a fully competitive position among chief executive officers of similarly-situated high technology companies and based on fiscal year 2001 performance.
During fiscal year 2002, Mr. McDonald was granted stock options of 400,000 shares. In combination with the grants of performance-based options and cash, discussed later in this section, the option grant was designed to be fully competitive with grants of long-term incentives to Chief Executive Officers by other comparable high technology companies.”
The actual process of gathering industry peer review compensation data is not an exact science, because not every company within the same industry group will have the same market capitalization, number of employees and revenue. For example, “Scientific-Atlanta positions its base salaries to be fully competitive with the range of compensation levels of high-technology companies and with Scientific-Atlanta’s direct business competitors that have similar market characteristics. National surveys and, periodically, independent compensation consultants are utilized by the HRCC when determining such salaries.” 2002 Proxy Statement. In addition, similar companies in the same industry code will often have subsidiaries that operate in different industry code classifications. Finally, not every executive position is identical with comparables in the same industry. For example, exploding growth companies will often attract top performing industry executives and provide enhanced compensation packages, as compared with similar executives in mediocre performing companies.
The industry peer review and benchmarking process is not entirely determinative of competitive pay packages. Other non-economic factors should be taken into account when analyzing compensation pay.