3M benchmarks its CEO's pay against 19 industrial companies, according to the 2014 proxy, yet three times that number – 62 companies – peg their boss's compensation to 3M, pay tracker Equilar found.
At the debate, Kay defended peer groups as "flawed" but "the only game in town" for simulating a market quote for CEO talent. And he dismissed as yesterday's headline the suspicion that some boards select peer groups to maximize the boss's pay rather than to mirror the company's performance.
"That game is over!" Kay bellowed. Compensation consultants and directors defend their choices as qualitative as well as quantitative, reflecting experience and the companies' unique characteristics.
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While Kay's CEOs may deserve to be better compensated than their peers, traditional peer-group analysis "understates" the extent to which they may be overpaid, says de Vaan, a Ph.D. candidate in economic sociology at Columbia University. Twenty-nine out of 50 big-company clients advised by Pay Governance remunerated their CEOs above the 50th percentile, averaging $4.7 million more apiece in 2011, according to the proxies de Vaan reviewed. The average for the group, including under payers, was $1,636,681 more than the median named peer, de Vaan found. Five companies that benchmarked CEO pay against an index, or provided insufficient information were not analyzed. I extracted the identities of Pay Governance's S&P 500 clients from the index companies' proxy disclosures.
De Vaan then randomly produced 100 alternative peer groups for each client. The simulations involved replacing every peer with an alternative closely resembling the benchmarking company, based on three separate measures: annual revenue, market capitalization and the Global Industry Classification Standard. He found that Pay Governance's boards chose CEO benchmarks with an upward pay bias of $1.4 million relative to other companies with similar identifying characteristics. Add to this the $1.6 million the companies already pay more than their named median peer, and it means that, on average, the CEOs of Pay Governance's S&P 500 clients are granted $3 million more than their simulated peers.
"Even firms that employ CEOs who have not excelled in the last year have the tendency to adjust the peer groups opportunistically in the next year," says de Vaan, drawing from an unpublished paper co-authored with Columbia Sociology Professor Tom DiPrete, "Setting Executive Pay: Bias in the Change of Compensation Peer Groups," which examines benchmark relationships at 1,348 U.S. corporations.
Two of Kay's clients, DirecTV and Alcoa, illustrate how peer selection can benefit the CEO.
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DirecTV CEO White joined the company in late 2009 just as Kay was picking up the board contract from his former employer, Watson Wyatt. DirecTV deleted British Sky Broadcasting from its 15-member media peer group for 2012 "because of the limited access to executive pay data" in the U.K., according to the 2013 proxy statement. British Sky paid CEO Jeremy Darroch $4.6 million in 2012, according to Sky's compensation report, making it by far the lowest-paid peer in DirecTV's benchmark group.
In its place, DirecTV restored former benchmark Charter Communications, "because it had emerged from bankruptcy," according to the proxy statement. Charter had actually exited bankruptcy three years earlier, eight months after filing. More recently, the company doubled its CEO's pay to $20.5 million, almost five times more than British Sky paid. Disney, Time Warner and Viacom also are DirecTV peers, and three of the four highest-paying companies relative to their peers in the Pay Governance client portfolio of S&P 500 companies, de Vaan found.
| PICKING PEERS AT DIRECTV |
| DirecTV replaced British Sky Broadcasting as a peer in 2012 "because of the limited access to (its) executive pay data," according to the company's proxy statement. Charter Communications returned, after removal in 2010, "because it had emerged from bankruptcy." In fact, Charter left bankruptcy three years earlier and British Sky continues to report compensation. The swap produced a five-fold increase from DirecTV's previously lowest-paid peer. |
| COMPANY || CEO PAY |
| CBS || 69,900,677 |
| Discovery Communications || 52,404,119 |
| Viacom || 43,123,552 |
| Walt Disney || 31,363,013 |
| News Corp. || 30,022,292 |
| Time Warner Inc. || 25,938,721 |
| *Charter Communications || 20,538,347 |
| Time Warner Cable || 16,433,828 |
| Liberty Global || 13,814,211 |
| Sprint Nextel || 11,882,651 |
| Cablevision Systems || 11,445,228 |
| Dish Network || 9,845,632 |
| CenturyLink || 8,554,284 |
| DirecTV || 5,937,078 |
| Gannett || 4,693,809 |
| **British Sky Broadcasting† || 4,378,030 |
| Source: 2012 SEC proxy filings || *Charter Communications added to peer group. |
**British Sky Broadcasting deleted from peer group.
†British sterling converted to U.S. dollars
Another Kay client, Alcoa, benchmarked Chairman and CEO Klaus Kleinfeld's pay to the median of dual titled chairmen-CEOs at Coca Cola, Google, McDonald's, Merck & Co. and Time Warner, among others.
"Our aluminum industry peers do not provide an adequate basis for compensation purposes because there are too few of them, they are all located outside of the United States and they do not disclose sufficient comparative compensation data," Alcoa said in its 2012 and 2013 proxy statements, after Kay took over the board compensation-consulting contract. Yet only 20 percent of Alcoa's public company peers reciprocated — nine out of 46, according to a review of the companies' 2013 proxies — while three others were a privately owned grocery wholesaler, a not-for-profit foundation and the office-products subsidiary of a foreign corporation, whose peer information is not readily available.
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Alcoa decided "to develop a more relevant peer group to inform compensation decisions for the CEO" last November, the company stated in its March 2014 proxy statement. The decision came 10 months after the Conference Board debate. Instead of consumer companies and tech juggernauts, the new reference group encompasses 19 materials and industrials companies such as Freeport-McMoRan Copper & Gold, Newmont Mining and U.S. Steel, nearly half of which (eight) consider Alcoa peers.
| SETTING THE BENCHMARKS |
| Under pressure to justify CEO pay, boards frequently compare the top executive's compensation to a self-selected group of peers.* The leading benchmarks for Standard & Poor's 1500 companies |
| CATEGORY || NUMBER OF COMPANIES |
| Industry || 1,202 |
| Revenue || 920 |
| Market Capitalization || 693 |
| Competitor For Talent || 583 |
| Business Model || 431 |
| Direct Competitor || 286 |
| Geography || 249 |
| Assets || 223 |
| Number of Employees || 157 |
| Profitability || 121 |
| Source: Equilar || * 91% use one peer group, 8% use two peer groups |
The new group still doesn't include direct competitors Aluminum Corporation of China or Shandong Nanshan Aluminum Co.; Australia's Alumina Ltd.; India's National Aluminium Co. Ltd.; Norway's Norsk Hydro ASA or Russia's United Co. Rusal, all of which are publicly traded. It's an indication that while labor has become a global commodity, CEO pay remains something of a local proposition.
"Executive compensation is a very puzzling and confusing and baffling subject for most investors," says management consultant Michael Levin, who writes The Activist Investor blog. "Every time we think we have a way to understand it better, it gets worse. At some subconscious level, all the pay consultants, not just Ira Kay, are doing this not just to reward people — but to make it more opaque."
—By Elliot Blair Smith of The Fiscal Times