While the use and selection of peer groups in setting executive pay has come under fire as the spotlight on compensation has intensified, criticisms that firms cherry-pick peers with higher pay or economic traits related to higher pay to justify boosting compensation may be unfounded, according to a recent academic study.
The study,
Compensation Peer Groups and their Relation with CEO Compensation, found “little evidence that firms choose peers opportunistically,” write authors Brian Cadman, Mary Ellen Carter, and Katerina Semida.
Previously little information on
peer group selection was available. However, that changed when the Securities and Exchange Commission adopted
revamped rules in 2006 that requires companies to disclose far more information about their pay-setting practices.
The report is based on analysis of data from the proxies of 608 S&P 1,500 companies. Of all the characteristics examined, the study found evidence of opportunism only with respect to the selection of larger peers, says Carter, an associate accounting professor at Boston College.
“In all other economic characteristics, firms seemed to select peers that were closer to themselves than other firms that they might have selected,” she says. Still, she notes, “We can’t rule out the possibility that opportunism existed before the new SEC rules and that mandated disclosure curbed the selection of biased peers.”
Firms were more likely to select peers that operated in the same industry and that had selected them as a peer, both suggesting that firms seek out peers that resemble themselves, says Carter. While the selected peers tended to be larger and better performing than the potential peers, she says only the size difference was related to higher pay in the sample firm.
“Based on our findings, there doesn’t seem to be widespread evidence lots of cherry picking going on,” says Carter.
Despite choosing better performing firms that are more different from the sample firm than other potential peers, the differences in performance don’t translate into higher pay for sample firm CEOs. Rather, the study found that pay in peer firms provided a benchmark. When pay (salary and total compensation) that wasn’t explained by the economic characteristics was higher, it led to higher pay in the sample firm, but when it was lower, it led to lower pay in the sample firm.