Get Out Your Pitchforks?

News Brief
October 5, 2011

By Cydney Posner

Articles on executive compensation continue to stoke the flames for the protesting 99%. For example, this evening's PBS Newshour has a segment decrying excessive executive compensation. And here's a link to a long "Special Report" in the Washington Post called "Breakaway Wealth: Cozy relationships and ‘peer benchmarking' send CEOs' pay soaring."  The article focuses on one CEO who received a 37% increase (from $15M to $21M), notwithstanding the fact that his company's shareholders had lost 3% on their investments in 2010 and 7% over the past five years." Even uglier, as the CEO tried to cut costs, the "company had been forced to close or shrink plants, trimming the workforce from 20,100 to 17,400."

Why the increase? It all came down to benchmarking. The article reports that the compensation committee decided to pay the CEO "more than most chief executives in the industry — with a compensation ‘value closer to the 75th percentile of the peer group,' according to a 2011 regulatory filing." The article reports that, since the SEC's new compensation disclosure rules went into effect and compensation committees' methodologies have been revealed, "researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward. Moreover, the jump in pay because of peer benchmarking is significant. A chief executive's pay is more influenced by what his or her ‘peers' earn than by the company's recent performance for shareholders, according to two independent [academic] research efforts based on the new disclosures…. ‘Peer benchmarking has a significant influence on CEO pay,' [one of the academicians] said. ‘Basically, you can't have every CEO paid above average without pay ratcheting upward over time.' "

Significantly, in creating the peer groups, boards and consultants often select companies that are substantially larger and, as a result, can lead to increased pay: "The practice of choosing peers that boost pay is common. [Academic and ISS studies] have shown that when choosing ‘peers' for pay-setting purposes, companies tend to choose larger firms or firms with more highly paid chief executives." Moreover, "because of peer benchmarking, raises at one company have ripple effects across corporate America." According to the article, 37 other companies, some in completely unrelated industries, named the subject CEO's company as a peer. Next year, that company will use the other companies as peers, causing pay to spiral upwards.

The article also questions the way in which share awards vest: not only do many awards vest on the basis of time served, but even if vesting is based on performance goals, pay levels disclosed may not really be at risk. This factor is especially important because "stock compensation tends to be the largest component of executive pay." Companies view stock compensation as a good incentive to increase shareholder value generally and, if subject to performance vesting, stock awards can put a large component of pay "at risk." However, the article questions how much of reported pay really is in serious doubt: the compensation numbers for performance awards reported in the comp tables reflect companies' assessments of "probable" financial outcomes.

Nevertheless, peer benchmarking persists despite critics such as Peter G. Peterson, former chairman of the Federal Reserve Bank of New York, John Snow, former chairman of the Business Roundtable, former Fed chairman Paul Volcker and investor Warren Buffett. The article attributes the prevalence of peer benchmarking to the unwillingness of corporate board members to abandon the practice, largely because of the high incidence of board members who have personal or business relationships with the CEO: "On a typical board, the chief executive considers about 33 percent of the board of directors as ‘friends' rather than as mere ‘acquaintances,' according to a survey of chief executives at about 350 S&P 1500 corporations conducted over 15 years by [a] University of Michigan business professor…. More tellingly, the chief executive is likely to find even more friends on the compensation committees of corporate boards — almost 50 percent." As a result, some board s are viewed as "basically just rubber-stampers."

At the same time, the article argues, the "gap between what workers and top executives make helps explain why income inequality in the United States is reaching levels unseen since the Great Depression. Since the 1970s, median pay for executives at the nation's largest companies has more than quadrupled, even after adjusting for inflation, according to researchers. Over the same period, pay for a typical non-supervisory worker has dropped more than 10 percent, according to Bureau of Labor statistics." <br>

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