(Editor’s note:
This post is by
Carol Bowie of the
RiskMetrics Group Governance Institute.)
Enhanced proxy pay disclosures, which the SEC believed would
assist shareholders trying to assess the efficacy of executive
compensation at their portfolio companies, have mainly underscored
the elaborate and opaque nature of most pay programs. A new paper
from RiskMetrics Group entitled Explorations in Executive
Compensation aims to guide shareholders through the maze of
terminology and complex processes being detailed in proxy statements
and -– importantly -– proposes two innovative techniques that may
help both investors and directors clarify disconnects between
executives’ pay and shareowners’ interests.
You can view the paper, along with interactive tools that
illustrate these techniques, at
www.riskmetrics.com/compensation. RMG is seeking a range of
feedback to help refine the paper and the potential tools.
The first proposed technique focuses on peer group benchmarking
-– long suspected of contributing to spiraling pay levels that
cannot be linked to consistently superior returns. Academic
literature has demonstrated the importance of benchmarking in the
pay process (e.g., see Faulkender and Yang’s, “Inside the Black Box:
The Role and Composition of Compensation Peer Groups.” Working
Paper). But RMG may be the first to create a model to consistently
measure the quality of a company’s peer group in terms of its
homogeneity (relative to size and industry factors) as well as the
company’s rank within the peer group relative to the benchmarks it
targets – identifying where a company that is the smallest in the
group targets pay at the seemingly innocuous median level, for
example. Do such distortions contribute to pay inflation? The data
are revealing.
The second technique brings a financial markets perspective to
evaluating how a CEO’s pay package is or isn’t aligned, in terms of
risk, with that of shareholders. Understanding that alignment -– or
misalignment -– can identify companies where incentives may be
motivating a top executive to pursue strategies (e.g., high- or
low-risk) that don’t fit with a shareowner’s investment goals or
even the board’s declared business strategy.
RMG’s project is ambitious in scope and intent — to help bring
clarity to the often thorny and always complex issue of executive
pay. But it epitomizes our objective of producing thought provoking
research that creates constructive dialogue on the important
corporate governance issues facing investors and corporations. The
goal is to create a shared language and measures that market
participants can use to create, evaluate, and communicate about
executive pay systems. The project is offered in the spirit of RMG’s
commitment to bringing transparency, expertise and access to all
financial market participants, and a vital part of the project is
the feedback we get from all market participants. We invite your
comments at
www.riskmetrics.com/compensation.
