What happens when there is no consistency when evaluating a company’s proxy statement and their peer group? We are beginning to find out now.

With the recent trends of greater scrutiny in executive pay, it is becoming more and more important for companies of ALL shapes and sizes to properly evaluate how they pay their top line of executives. But, with more focus on this practice – it is becoming evident that both the companies who are being scrutinized, as well as those doing the scrutinizing have not found a common ground on how to evaluate themselves. This was highlighted recently in a Wall Street Journal article titled “Watchdog Challenged Over Pay Benchmarks”.

To give you some background: for the past 30 years, companies (both public and private) have created peer groups in order to compare/benchmark themselves against similar companies with respect to executive pay. These peer groups are typically made up of 10-14 companies that the target firm deems similar in industry and size. Now, because each firm creates their own peer group (hopefully with help from a compensation consultant) investors have become apprehensive that the peers chosen were chosen in order to help make the target firm look in line with the market. Because of this apprehension, proxy advisor firms such as Institutional Shareholder Services (ISS) have gained popularity.

The issue with these firms, though, is that as they make their research public – they too are inconsistent in their peer group selection process, as it is evident with their recent recommendations to Starwood Hotels and Marriott Corp. So, as the shareholders go to vote on the pay practices of the firms they trust their money with – how can they trust the advice of this “Watchdog”? As the world begins to take a greater interest in this subject, it is obvious that we must find common ground in the “Peer Group Selection Process”. In order to do this a hybrid approach should be taken.

Nobody knows your peers quite like you do. This is where any company should start, by listing out any direct competitors – being companies you might compete with for both executive hiring and products/services. Now, this is where common sense plays: you know how well your company performs and how well it is capable of performing. Thus, the peers’ financial metrics you select should fall within a reasonable range. Every company and industry is different, but ISS recommends a range of 0.45-2.1x for the target company’s total revenues and 0.2-5x the target company’s market cap. While these ranges can be tweaked, they are a fine starting point. If there is trouble finding enough practical peers, the Board or consultant should find viable additions in the target’s related industry. This can be easily attained by using Standard & Poors’ SIC Code database.

If we could all just agree to take on a similar selection process, we wouldn’t have to have the “Peer Group Debate”. Right now, though, it is evident that as long as there are inconsistencies with identifying peer groups, we must use our own common sense when evaluating these companies.

You can read the mentioned WSJ article here. Please contact me at apluta@burke.com if you have any comments.