Remuneration committees typically benchmark various elements of an executive’s remuneration package against what is paid at a group of comparator companies. Known as the company’s peer group, the comparator companies may be in the same industry or have similar market capitalization. Benchmarking is done to ensure that companies are able to compete with their peers for talent by paying similar amounts. The benchmarking exercise was cleverly coined an arms race by Michael Kagan, a senior portfolio manager at ClearBridge Investments. When one peer increases its remuneration packages, all of the other peers can justify following suit.
A little known fact about the arms race is that some executives sit on the remuneration committees of their peers. While an executive would not be permitted to determine his own pay directly, he can influence what he is paid by increasing his peer’s remuneration. By ratcheting up pay at the peer company, the executive is able to justify a larger pay package for him or herself.
For example, while he was the CEO of eBay, John Donahoe was also a member of the compensation committee at Intel Corporation. eBay’s annual report lists Intel in its peer group. This problem is not limited to American companies. Ian Cheshire, the now former-CEO of Kingfisher, sits on the remuneration committee at Whitbread. Kingfisher’s annual report indicates that it benchmarks itself against companies in the FTSE 25-75, a group that includes Whitbread.
Finally, Michael Roney, CEO of Bunzl, was on the remuneration committee of Johnson Matthey. Johnson Matthey’s annual report does not disclose its peer group for the purpose of benchmarking salaries, but it does describe it as a group of UK companies that have substantial operations overseas. Additionally, the report discloses a list of 40 comparator companies used for determining whether incentives should vest. This list includes Johnson Matthey and is described as “40 UK based companies…that have substantial operations overseas and…similar levels of revenue, profit and market capitalisation as Bunzl.” Given that the description of this peer group is very similar to the one used for benchmarking salaries, it is probably safe to assume, although one cannot be sure, that Johnson Matthey is also considered a peer for the purpose of benchmarking salaries.
Some remuneration committees specifically exclude companies from the peer group when an executive sits on that peer’s remuneration committee. For example, Diageo specifically excludes Unilever from its peer group because Paul Walsh, Diageo’s CEO, sits on its remuneration committee. This should be seen as best practice – it is not appropriate for executives to sit on the remuneration committees of peers used to determine that executive’s remuneration. Other remuneration committees should take a page out of Diageo’s book and exclude these peers from consideration.
Additionally, the UK Corporate Governance Code should be amended to either prohibit this type of situation or at the very least to require its disclosure to shareholders. Currently, many shareholders will have no idea if an executive sits on the remuneration committee of a peer. While companies must disclose whether directors sit on the boards of other companies, as we have seen with Bunzl, there is no requirement to list which companies are contained in their peer group. This lack of information permits this problematic practice to continue without appropriate shareholder scrutiny.
The arms race continues, but some executives have an unfair advantage. Shareholders should be provided with information about company peer groups. Executives should not sit on the remuneration committees of companies within their peer group. These steps will not stop the arms race, but at least they will remove a tactical advantage.