Who’s in Your Peer Group?
The first thing to do is to decide which companies should make up your peer group, says Boyd. Should you compare to companies:
- Against whom you compete for business?
- Whose revenues are approximately the same as yours?
- With about the same number of employees?
- In the same industry?
Isn’t there someone out there who can just hand you a list of the best companies against which you should compare?
Before you get too frustrated, bear in mind that this kind of self-examination is relatively new, says Boyd, a researcher at Boston-based compensation consultant Equilar. It’s only been since 2006, he notes, when the Securities and Exchange Commission began requiring publicly traded companies to disclose their peer groups, that the information became readily available to the public. If you’re thinking about the best way to choose a peer group, you’re ahead of many companies, even very large ones, says Boyd.
Properly setting pay is always important because it can mean the difference between attracting the talent you need or losing them to another company. (Or, overpaying and throwing away profits.) But as the recession begins to pull back, you especially need to make sure your pay package is competitive by comparing yourself against a well-chosen group of peer companies, Boyd says.
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With the recent availability of peer group data, Equilar, which studies executive compensation data, decided to compile the information so it can be easily analyzed. The company also created a tool that allows clients to perform ‘what-ifs’ by plugging different companies into their peer group models, and learning which companies are benchmarking back to them.
“Choosing a peer group is a tricky thing,” says Boyd. And while you might wish they would, Equilar will not provide you with a list of recommended peers. “But we can help you,” he explains, “if you’re looking for a list of companies that fall within a certain range of revenue, or market capitalization, or whatever metric you want to use.
“The tricky part,” he says, “is that this isn’t as much a science as it is an art; the companies you feel are most closely aligned to your business model, with whom you compete, who are around your size, may not feel that you are comparable to them.
“So there is not a specific list of companies that you should be benchmarking to. Instead, the challenge is figuring out which companies will provide the right group for you to make the best compensation decisions for your organization.”
Size Matters—And So Do Other Factors
Why is the selection of your peer group so important? Boyd offers this exaggerated illustration. A small retailer that benchmarks itself against Wal-Mart, Target, and Kohl’s would find CEO pay that is much higher than they would need to pay, he says.
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“It would be much higher than what would be feasible, or even sensible, for that company. If you choose a peer group, then, of companies that are much larger and more complex than your company, there is the potential that you will overpay your executives. And conversely, if you were to underpay them because you chose companies that are too small and with jobs that just aren’t comparable, you end up paying less than they can get elsewhere. Then you run the risk of losing them to another company,” Boyd explains.
“Proper selection of your peer group is the foundation of a sound compensation program,” he emphasizes. “If you’re comparing to the wrong group of companies, then any assumptions or decisions, no matter how sound within that peer group, could potentially be errant and viewed as bad decisions, simply because you’ve got the wrong group of companies.”
In tomorrow’s Advisor, Boyd on “peer group arms races,” and an invitation to an exclusive webinar on base Pay and Pay Grades in the “New Normal.”