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Meaningful Peer Comparison
Peer group comparison forms the cornerstone of the entire C&B process, ensuring that the company’s pay structure is competitive, enabling the company to attract, motivate & retain talent.
Most importantly, peer group comparison brings defensibility to the company’s chosen C&B strategy, providing external validation to shareholders that the chosen pay structure, scale & magnitude is reasonable relative to results achieved.
Companies typically establish a peer group comprising of 11 to 15 equals. Outliers containing deviant data will bias the analysis if there are fewer than 9 equals in the peer group. Administrative costs will exceed return-on-peer-group-analysis-investment for peer groups of 16 equals or more.
There are various screening methods companies employ when establishing peer groups.
Screening by market capitalization
If a peer group is selected based primarily on market capitalization, the companies that make up that peer group will change constantly because market capitalization is a volatile metric. Market capitalization is driven by market sentiment of the company’s perceived future value, so it may not accurately reflect the current business’s size or scope.
Companies included in the peer group based on market capitalization will drop in & out of the peer group with higher frequency as compared to companies included based on revenue or asset value.
If, at the beginning, the company is benchmarked with the 90th percentile of share price performers, but the company’s share prices decline in the following year to the 40th percentile, the company will be forced to redesign the C&B reward structure to match lower performance expectations. This is why peer group selection should not be based primarily on market capitalization.
Maintaining stability of peer groups
A well selected peer group only needs to be reviewed every 3 years. Ensuring continuity of companies in the peer group allows C&B trends to be monitored accurately.
Frequent peer group review leading to changes in peer group composition will lead to inconsistencies when conducting yearly analysis on C&B trends. Shareholders will also accuse the compensation committee of not being independent, favoring management by pegging C&B practices higher in accordance with market pay leaders, leading to management profiting from the C&B peer group benchmarking exercise.
Peer group companies need to be re-evaluated when there is a change in business economics, for example, if peers undergo a merger & acquisition that results in a change of business portfolio, or when the company itself releases a new product or service & enters a new market to compete with new competitors.
Many companies make the mistake of delaying peer group re-evaluation, often waiting up to seven years before conducting a follow-up peer group benchmarking exercise. By that time, the company’s C&B pay levels & practices will have most certainly become uncompetitive & obsolete, resulting in a serious bleeding of talent & losing valuable institutional knowledge in the process. The company will try to re-hire, but will find that it can only attract mediocre candidates. Mediocre employees produce unexceptional work, & the company will achieve unremarkable business performance at best.
Most importantly, peer group comparison brings defensibility to the company’s chosen C&B strategy, providing external validation to shareholders that the chosen pay structure, scale & magnitude is reasonable relative to results achieved.
Companies typically establish a peer group comprising of 11 to 15 equals. Outliers containing deviant data will bias the analysis if there are fewer than 9 equals in the peer group. Administrative costs will exceed return-on-peer-group-analysis-investment for peer groups of 16 equals or more.
There are various screening methods companies employ when establishing peer groups.
- Screening by customer - Prospective peer group companies are those that compete with your company for customers, & therefore, revenue.
- Screening by labor - Prospective peer group companies are those that recruit people of the same talent profile as your company. Generally, companies which compete for the same customers tend to compete for the same employees as well.
- Screening by capital - Prospective peer group companies are those which compete with your company for equity or other forms of capital. Generally, companies which compete for the same capital share similar financial metrics.
- Screening by revenue or asset value - Large companies are more capital & asset intensive, & typically have more complex operational structures, resulting in executives having jobs with broader scope with greater overall responsibility.
- Screening by organizational structure - The roles & responsibilities of an executive overseeing a large conglomerate consisting of several subsidiaries will differ greatly from an executive who is charged with running a single entity company. The conglomerate will build its C&B strategy to focus executives on business portfolio optimization, whereas the single entity company will choose a strategy that emphasizes more on operational excellence.
Screening by market capitalization
If a peer group is selected based primarily on market capitalization, the companies that make up that peer group will change constantly because market capitalization is a volatile metric. Market capitalization is driven by market sentiment of the company’s perceived future value, so it may not accurately reflect the current business’s size or scope.
Companies included in the peer group based on market capitalization will drop in & out of the peer group with higher frequency as compared to companies included based on revenue or asset value.
If, at the beginning, the company is benchmarked with the 90th percentile of share price performers, but the company’s share prices decline in the following year to the 40th percentile, the company will be forced to redesign the C&B reward structure to match lower performance expectations. This is why peer group selection should not be based primarily on market capitalization.
Maintaining stability of peer groups
A well selected peer group only needs to be reviewed every 3 years. Ensuring continuity of companies in the peer group allows C&B trends to be monitored accurately.
Frequent peer group review leading to changes in peer group composition will lead to inconsistencies when conducting yearly analysis on C&B trends. Shareholders will also accuse the compensation committee of not being independent, favoring management by pegging C&B practices higher in accordance with market pay leaders, leading to management profiting from the C&B peer group benchmarking exercise.
Peer group companies need to be re-evaluated when there is a change in business economics, for example, if peers undergo a merger & acquisition that results in a change of business portfolio, or when the company itself releases a new product or service & enters a new market to compete with new competitors.
Many companies make the mistake of delaying peer group re-evaluation, often waiting up to seven years before conducting a follow-up peer group benchmarking exercise. By that time, the company’s C&B pay levels & practices will have most certainly become uncompetitive & obsolete, resulting in a serious bleeding of talent & losing valuable institutional knowledge in the process. The company will try to re-hire, but will find that it can only attract mediocre candidates. Mediocre employees produce unexceptional work, & the company will achieve unremarkable business performance at best.
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