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CEO Pay As Governed by Compensation Committees: The Model WorksPay Governance, one of the largest independent board executive compensation advisory firms, asserts that the CEO pay model is working well and is a source of competitive advantage. Last year, two academic professors published articles in the Wall Street Journal and Harvard Business Review 1,2 criticizing the executive pay model used at U.S. companies. Their thesis was that CEO compensation has become excessive due to poor governance practices (e.g., poor disclosure, misleading performance metrics and inappropriate peer group selection) employed by Board Compensation Committees. Pay Governance refutes the assertion that Compensation Committees' decisions and governance lead to excessive CEO pay. "The CEO labor market is relatively efficient and U.S. corporate governance- Say on Pay (SOP) votes, lead directors and stock ownership guidelines, among many other enhancements-is strong and has improved over the past 20 years," said Pay Governance Managing Partner Ira T. Kay. The firm rebuts the authors' specific criticisms of CEO compensation by focusing on three counter-arguments:
Since 2011, shareholders have provided an advisory vote for their overall approval or disapproval of a public company's executive compensation program as disclosed in their annual proxy. Overwhelmingly, shareholders have strongly supported corporate executive pay programs by approving the CEO pay model. In fact, 98-99 percent of all filing companies have received positive votes over the past seven years, with additional support indicated in this eighth year. "The strong support and favorable shareholder voting results in favor of corporate executive pay programs occurred due to the extensive testing, demonstration and disclosure of the strong alignment between CEO pay and corporate performance," Kay said. "Shareholders are able to recognize the correlation between CEO pay and company performance, and to the extent hat shareholders experience aligned returns on their investment, they will vote in favor of the company's approach to executive compensation." Another major criticism from the articles concerns the use of non-GAAP performance metrics to design incentive compensation plans. Pay Governance acknowledges that many companies use non-GAAP metrics such as adjusted EPS and EBITDA in their incentive plans; however, such metrics are implemented for legitimate reasons and are supported by shareholders. There are several reasons to choose non-GAAP metrics for performance measurement, including a company's desire to focus management's primary attention on core operating earnings. Another important consideration is the consistency of these incentive adjustments with those in the earnings releases. As shown in a recent Pay Governance review, academic research reports that the investment community relies on adjusted earnings and non-GAAP measures. Another criticism of the CEO pay model is the selection of inappropriately large peer companies for the annual assessment of a company's financial performance and pay competitiveness. In the annual proxy, companies are required to disclose the peer group used for this assessment. Despite an absence of specific guidance from the SEC (News - Alert) and other regulatory authorities about what constitutes a proper peer group, U.S. companies engage in a rigorous process to select a peer composition for benchmarking. "As consultants, our experience has been that companies engage in a rigorous and analytical process each year to identify peers that properly reflect the industry sector, size, and labor markets in which the subject company competes," said John Ellerman, Pay Governance Partner. "Some critics think that certain companies are cited as peers because of the desire to skew the competitive benchmarking to higher paying companies, but the facts do not bear this out. Companies attempt to include companies that realistically reflect potential competitors for executive talent." Finally, Pay Governance has found that the CEO pay model, as practiced by the majority of U.S. companies, has been a source of strength and competitive advantage, creating significant gains for all shareholders and stakeholders. To learn more about this Pay Governance study or to schedule an interview, call Don Rountree at (770) 645-4545. Pay Governance LLC is an independent consulting firm focused on delivering advisory services to Compensation Committees. The consultancy also advises the management of companies in situations in which the firm does not serve as the independent committee advisor. Pay Governance has locations through the United States in New York, Boston, Detroit, Philadelphia, Pittsburgh, Chicago, St. Louis, Dallas, Cleveland, Charlotte, Atlanta, St. Petersburg, San Francisco and Los Angeles. The firm also has strategic affiliate relationships with Pay Governance Japan and Pay Governance Korea. For more information, visit www.paygovernance.com.
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