Study: Peer grouping with minimal board discretion seriously flawed
NEW YORK, NY – The Investor Responsibility Research Center Institute (IRRCi) will host a webinar on a new study authored by Charles M. Elson and Craig K. Ferrere of the John L. Weinberg Center for Corporate Governance at the University of Delaware.
Executive Superstars, Peer Groups and Over-Compensation – Cause, Effect and Solution finds that an over-reliance on peer group compensation benchmarking is central to the persistent issue of rising executive pay in the United States.
While other research examines flawed peer group methodology, this new study makes it clear that peer grouping with minimal board discretion is a seriously flawed methodology even when the peer groups are fairly constructed. The study also is the first to document that peer group benchmarking – now so widely utilized that it is enshrined in federal regulations – has accidentally become the de facto standard even though it never was designed to determine CEO compensation.
Charles Elson, Co-Author and Chair in Corporate Governance and Director of the John L. Weinberg Center for Corporate Governance at the University of Delaware
Craig Ferrere, Co-Author and Edgar S. Woolard Fellow in Corporate Governance at the Weinberg Center
Jon Lukomnik, IRRCi Executive Director
The research paper argues that:
- Theories of optimal market-based contracting are misguided because they are based on the notion of vigorous, competitive markets for transferable executive talent;
- Even boards comprised of the fiduciaries faithful to shareholder interests will fail to reach an agreeable resolution to compensation when they rely on the flawed and unnecessary process of peer benchmarking;
- Systemically, a formulaic reliance on peer grouping will lead to spiraling executive compensation, even if peer groups are well constructed and comparable; and
- The solution is to avoid arbitrary application of peer group data to set executive compensation levels. Instead, compensation committees must develop internal pay standards based on the specific company, its competitive environment and its dynamics. Relevant considerations include an executive’s current and historic performance and internal pay equity. Some reference to peer groups may be warranted, but the compensation process must maintain the flexibility necessary to arrive at a reasonable approximation to what is absolutely necessary to retain and encourage talent.
This research adds to the body of executive compensation research funded by IRRCi. A previous IRRCi study available here identifies companies with high pay that is not aligned with high performance. The Harvard Executive Compensation Research Series is available here.