Imagine that you’re a manager at a large, publicly traded company. You’re pretty happy with your salary, but the recent salary freeze means you won’t be getting the 5% raise that you deserve.
Then you find out that the CEO of your company brings home $14 million a year.
Or put yourself in the shoes of the board of directors. You know that the CEO makes $14 million.
And new legal requirements mean you have to tell the government, the media, and your employees that the CEO makes 250 times more than the median employee salary at the company.
Now imagine that you’re the CEO. Your salary is going to be published, along with the 250:1 ratio.
And you’re going to be expected to justify it.
Executive compensation issues are a real pain.
You want to pay your executives well. But publishing numbers like “$14 million” and “250:1” seem sure to damage morale at your company.
What do you do?
You look at the data. Before we get into which data points you should look at, though, a quick note:
Executive Compensation Issues Are Complex
It’s important to acknowledge just how complex executive compensation is. Even with real data to back up your decision, there are a lot of factors that don’t fit into a spreadsheet.
Here are just a few competing priorities at play:
- Paying enough money to prevent another company from poaching your CEO.
- Offering appropriate incentives for hitting goals to improve executive performance.
- Finding ways to pay for rising executive compensation costs.
- Justifying huge gaps in salaries to other executives and non-executive employees.
- Accurately calculating salary gaps and executive pay ratios.
- Managing tax burdens for the company and executives.
- The increasing importance of social justice to consumers.
A full breakdown of any one of those could fill an entire book. Which is why executive pay is such a complicated issue.
But They’re Worth Figuring Out
You might wonder if it’s worth taking the time to get these issues properly sorted.
Yes. It absolutely is.
Because poor executive compensation practices can reduce the performance of your company. As we’ll see momentarily, large unexplained pay disparities can cause problems like reduced sales and high turnover.
That’s bad for everyone, from front-line employees to executives to shareholders.
With that caveat out of the way, let’s get into the best way to solve your executive compensation issues:
Use Real Data Drive Executive Compensation
That’s it. Seriously. It’s that simple.If your executive compensation packages are driven by real economic data, your company will be more likely to succeed.
You might think that you’re using real data already, but many compensation committees use qualitative factors.
They might look at the median executive pay in a group of companies, then decide to offer some percentage more than the median because their company is some percentage better than those other companies.
Not exactly real data.
Here are five things you can use to not only make the right choice, but justify your decision. Which, as we’ll see, is important.
Real Data Point #1: Industry Benchmarks
Attracting and retaining executives requires competitive pay. So one of the first things that companies often do is to look at how much the CEOs of “equivalent” companies get paid.This is the first place that you can misstep.
Because most companies look at executives outside of their own industry. Steven Clifford writes in the Atlantic that these “peer groups” are supposedly of similar size and complexity, but often include a variety of companies in industries that are, in fact, irrelevant.
If you’re figuring out how much to offer a new CEO at a software company, don’t look at how much the CEOs of grocery store chains get paid. Those companies likely won’t be competing for your candidates, and running those companies is inherently different.
For their part,” says Clifford, “companies today stand by this practice.”They also have a tendency to offer more than the median salary in the chosen peer group, continually driving the average executive salary higher.
Here’s Clifford again: “every time a CEO gets a generously-benchmarked deal, he sets a higher baseline for the next time any leader has pay negotiations.”You can see how this spirals out of control rather quickly.
So what can you do when you’re trying to figure out how much to pay your executives?Look at relevant industry peer groups and their median pay. And don’t immediately assume that you should be paying in the 90th percentile of that group.
You may want to offer more than average. But remember that what you offer is going to contribute to the cycle of excessive executive compensation.
This seems like a good time to mention the fact that you don’t want to attract a CEO only with compensation. If the best thing you can think of to attract talented executives is offering more pay, you may want to take a look at your company culture and values.