Compensation Peer Group Voir Dire

So, I was recently doing my civic responsibility by serving on jury duty. As it happens, when I am just sitting around, my thoughts turn to compensation issues (just like yours!). A strange and crazy thought came to me. Imagine if your peer group for compensation was selected in the same manner as a “jury of your peers” in a criminal court case. Besides it being almost glacially inefficient, how would this historically proven method (even the ancient Greeks used it) for choosing one’s peers impact the world of compensation?

Let’s first review the current compensation peer selection process. A company sets its goals. Next, it decides on its peers, sometimes with the assistance of an outside professional, other times using only internal expertise. Key components usually include the industry and size of the company. There is sometimes a bias toward companies with similar compensation philosophies and/or pay levels. In all cases, companies use a combination of quantitative and qualitative factors to create a group that meets their specific needs.

Then shareholders, or their advisors, choose a peer group based on their goals. These peers are chosen more “scientifically” and often do not take into account company culture, idiosyncrasies, history or future business plans. The peers chosen by the company and those chosen by investors are often quite different. Imagine if criminal trials worked this way.

Look at it from the defendant’s perspective. The defendant would have a professional, in this case a lawyer, simply pick twelve people who have similar interests and backgrounds. Perhaps all of them would have a criminal history. Maybe all of them had been falsely accused in the past. Maybe interviews showed the group unanimously did not support the law that was allegedly broken. Justice would be easy. The charges would prove groundless and the case would disappear. People who disagreed would scream and yell from the sidelines and demand to have a voice.

How would this look if the prosecution controlled the process? The prosecutor would gather a group of citizens who had previously indicated that they not only supported the law, but also blindly trusted the people enforcing the law. The prosecution would just need to explain why the person was on trial and the verdict would likely go their way. Of course, both extremes are equally unjust.

In the world of compensation, especially executive compensation, we have both scenarios happening at the same time. Because both sides choose peer groups based on their own perspective, they both feel they are right. Because each side is 100% right, the other side is required to be 100% wrong.

Now imagine a world where peer groups were chosen through a debate between companies and investors, with a trusted overseeing figure making final decisions (the “Comp Judge”). Each side would put up its list of peers. The company and the investors would then evaluate these at the same time. Each side would be given the opportunity to remove some, but not all, of the peers suggested by the other. The Comp Judge would be able to replace rejected peers with new peers until an uncomfortable balance was achieved. Neither side would be perfectly happy. Neither side could say the peers were completely wrong. Final compensation levels and strategy for a given company would be linked to peer group market data that was specifically chosen for the current season and neither side could immediately dispute the decisions made.

Each side could appeal in future years (let’s two or three) and attempt to modify the peer group. This would only be allowed as long as a Comp Judge could be persuaded that there was a real issue with the last peer group decision.

Of course, this is all fantasy because companies would never give up their autonomy and some shareholders will always think that some companies are trying to game the system. But, you have to wonder if compensation creep (the inexorable rise of pay) and the related wailing and tearing of clothes would calm down a bit and let us put more focus into strategy, communication and business results.

Dan Walter is the President and CEO of Performensation an independent compensation consultant focused on the needs of small and mid-sized public and private companies. Dan’s unique perspective and expertise includes equity compensation, executive compensation, performance-based pay and talent management issues. Dan is a co-author of “The Decision Makers Guide to Equity Compensation”, “If I’d Only Know That”, “GEOnomics 2011” and “Equity Alternatives.” Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts, a free networking group. Dan is frequently requested as a dynamic and humorous speaker covering compensation and motivation topics. Connect with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay.

Comments

[E. James (Jim) Brennan]

Too big a topic, Dan. Athenian sortition (selection by lot) was restricted to quasi-municipal offices, like streets superintendant and parks manager, where a random citizen could be trusted over a nonessential activity. Defending the state was too important to leave to chance, so a Tryant or Strategos was selected via merit to lead the military. But a friend of mine is trying to encourage sortition at State and local government levels (see www.TheCommonLot.com).

Elections involve the adversarial process. too. Our justice system comes from pre-Socratic dialectic principles where opposing arguments are debated. Comp peer selection is too vital to be left to chance, but selecting a "comp judge" would be problematic. Having held that post many times, it's no fun.

Why should the innmates get to choose their jailers, anyway? Follow the Golden Rule: those who have the gold make the rules. The shareholders who own the company are literally entitled to define their desired peer comparison group. Management employees are hirelings who work at the pleasure of the ownership who set the direction and create the context. If they want to negotiate their peer group selection, they should either become owners who hold that power or find ways to influence their choices. I always thought they did that, already.

[Dan Walter]

Jim...why do I think you've had this discussion before? :)

I think the back and forth process would be helpful to both sides. Both would have to have reasonable arguments to justify their decisions. Both would have to think more strategically about the priorities of their goals.

I think finding "Comp Judges" would be easier than you may expect. In truth, I can't imagine many people would want to be a judge for criminal cases. Forced to follow the law even when it stuck in their craw. That being said some of out finest legal minds want to do just that.

[E. James (Jim) Brennan]

Should you negotiate your home decor with your plumber or lawn service? Of course not, because they are contractors whose activities on your property are under your control. The investors who are company owners should be calling the shots about the nature and destiny of their enterprise. If they want to make wacky peer comparisons, the employees can choose to stay or vote with their feet.

Granted, wise board comp committees wishing to maintain peace will retain independent advisors to provide expert assistance against the self-serving recommendations of the testimonial consultants hired by senior management. But there is nothing random about those interactions. Each side picks its champion while the board still controls the final decision.

[Marc Hodak]

Interesting perspective, Dan, as usual. It's refreshing to know that I'm not the only one who thinks about compensation issues in random places.

I don't know about the merits of a Comp Judge, but I generally disagree that investors should be involved in any aspect of substantive determinations of pay. Sure, they should be allowed to determine peers in comparing performance--they, in effect, do that automatically by virtue of their decision to invest. But public company investors are totally unqualified to make a priori strategic decisions, including regarding HR strategy, including who the company is competing with for talent.

Besides, 90% of the "peer selection" debate would evaporate if companies and their critics simply took a half-step up the statistical literacy ladder and used size-adjusted analysis to determine percentiles. We do this with our clients, and it eliminates all the debate about who is in or out of the peer group.

[Jules]

In Indonesia, I have heard of HR having a one on one meeting with a panel which decides if their job is comparable and should be added to the survey. Needless to say... the result is a monopoly by the group that held the panel.

[E. James (Jim) Brennan]

One of the smartest collective bargaining contracts I've seen gave the union significant control over the composition of the comparables (the new OFCCP term is "cohort") management was permitted to reference in support of the company position. That was at a Midwestern US energy firm. They always ended up being very very highly paid, of course.

The more you control the sample pool, the more likely you can pre-select your outcome.