How to Approach Executive Pay Vs. Employee Compensation
Recently, I was working with a General Counsel who was tasked with putting together an analysis of the pay for their top five leaders in preparation for their annual Board Meeting. As pay equity regulations trend towards increased levels of transparency and as organizations respond to the COVID-19 impact on the US economy, it is no surprise the Board wanted to take a closer look at their executive pay.
Luckily, this organization was not in a position where they needed to make layoffs to survive the pandemic, but I considered the thought of an organization who let go of a large population of their minimum wage workers and made no adjustments to executive pay. What would the implications of a media spotlight on a decision like that be for an organization? Likely terrible, and a strong crisis communication plan would need to be executed.
It may come as no surprise that executive compensation is subject to public scrutiny, legal regulations, and tax considerations which all impact the appropriate level of pay and the pay mix. It is often the target of media coverage as the earnings of top executives generate public discussion about the reasonableness and fairness of pay practices.
When I was speaking with this General Counsel, he shared that he understood that evaluating executive pay is different than employee pay, but that he was not sure where to begin. I thought maybe there are others who are in this same position who would appreciate further explanation.
The Differences Between Executive Compensation Vs. Employee Compensation
As a Senior Compensation Consultant at Helios HR, the approach I take to determining executive level pay is quite different than the approach to employee compensation:
- Executive compensation is typically determined through an analysis of the compensation of individuals in similar roles at comparable organizations to determine a reasonable rate of pay.
- Employee compensation is typically administered through a salary structure, establishing a range of pay for roles within the organization.
Peer Group Analysis
When evaluating executive level pay for a client, my team and I look to identify a list of 10-20 peer organizations. Peers are similarly situated organizations in terms of their mission and role in the marketplace. These are often who the organization competes with for business, but in addition to this group, it is important to consider who the organization competes with for talent.
For publicly traded organizations in the peer group, we will review the companies’ annual proxy statements that are filed with the SEC. For non-profit organizations in the peer group, we will review the companies’ Form 990s that are filed with the IRS. In these statements, pay details for executives are available and can be used to analyze base salary, bonus, and total cash compensation.
If the data set is large enough, we will look at the 25th, 50th and 75th percentile of the peer group’s executive pay. In addition, we often conduct a regression analysis to determine if there is a relationship between revenue size and executive pay.
In our experience, typically the larger the organization, the larger the total cash compensation for executives. When a linear regression is a good fit for the data set, we can identify where the organization’s executive pay lands on the trend line, based on their revenue size.
This approach to executive compensation is arguably more precise than leveraging salary surveys, which is common for employee compensation, as it analyzes pay for the individual executives in the comparator organizations.
Salary Survey Analysis
A market-based approach to employee compensation often leverages salary surveys to understand the market rate. Reliable salary surveys collect incumbent level data directly from an organizations’ payroll and are available by industry and geographic location.
To begin this analysis, we review each job description and select benchmark jobs from the survey. When determining the best match, we look for approximately 70-80% of the duties, education, and years of experience in the survey job to match the organization’s job. There is rarely an exact match between a benchmark job and the organization’s job because most organizations customize certain aspects of its roles to suit their unique needs.
The benchmark data is reported in percentiles for base salary and total cash compensation. An organization’s compensation philosophy drives the direction for salary structure development, but at a high-level, ranges of pay are developed based around the desired market reference point. Most commonly, organizations target the 50th percentile or median, to establish the midpoint of their salary range. This range of pay is then used to manage the compensation for employees.
When developing salary structures it is always a good idea to evaluate executive level pay as a part of that effort, as it helps sets the ceiling for pay within the organization from an internal equity perspective.
When developing executive compensation packages, many agree that pay for performance is the best approach, ensuring alignment between pay practices and an organization’s long-term goals.
While the approach to executive level pay and employee pay is different, the heavy lift comes in the first year of taking an active role in determining the market rate, given the effort in establishing a peer group and identifying benchmarks. Once that is complete, the effort is maintenance rather than building from scratch.
To stay competitive and ensure pay continues to align with the organization’s philosophy, it is important to continue monitoring the market. Helios recommends market data be reviewed on an annual basis. This review allows the organization to adjust their compensation strategy to reflect trends occurring in the market, and then translate that to better position compensation practices.