WashPost: "Cozy relationships and ‘peer benchmarking’ send CEOs’ pay soaring"

[Ted King]

http://www.washingtonpost.com/business/e...print.html

As the board of Amgen convened at the company’s headquarters in March, chief executive Kevin W. Sharer seemed an unlikely candidate for a raise.

Shareholders at the company, one of the nation’s largest biotech firms, had lost 3 percent on their investment in 2010 and 7 percent over the past five years. The company had been forced to close or shrink plants, trimming the workforce from 20,100 to 17,400. And Sharer, a 63-year-old former Navy engineer, was already earning lots of money — about $15 million in the previous year, plus such perks as two corporate jets.

The board decided to give Sharer more. It boosted his compensation to $21 million annually, a 37 percent increase, according to the company reports.

Why?

The company board agreed to pay Sharer more than most chief executives in the industry — with a compensation “value closer to the 75th percentile of the peer group,” according to a 2011 regulatory filing.

This is how it’s done in corporate America. At Amgen and at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.

The idea behind setting executive pay this way, known as “peer benchmarking,” is to keep talented bosses from leaving.

But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the “Lake Wobegon” effect.

It wasn’t until recently, however, that its pervasiveness and impact on executive pay became clear. Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Since then, researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.

Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her “peers” earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.

“Peer benchmarking has a significant influence on CEO pay,” Bizjak said. “Basically, you can’t have every CEO paid above average without pay ratcheting upward over time.”

‘All the other kids have one’

The gap between what workers and top executives make helps explain why income inequality in the United States is reaching levels unseen since the Great Depression.

Since the 1970s, median pay for executives at the nation’s largest companies has more than quadrupled, even after adjusting for inflation, according to researchers. Over the same period, pay for a typical non-supervisory worker has dropped more than 10 percent, according to Bureau of Labor statistics.

Critical to executive pay levels is peer benchmarking.

Even before the extent of the practice was known, it drew criticism from prominent business figures. After the Enron scandals, a blue-ribbon committee led by Peter G. Peterson, then chairman of the Federal Reserve Bank of New York, and John Snow, former chairman of the Business Roundtable, called for setting executive pay “unconstrained by median compensation statistics.” Legendary investor Warren Buffett, in one of his famously plain-spoken letters to investors, likewise derided the method.

“Outlandish ‘goodies’ are showered upon CEOs simply because of a corporate version of the argument we all used when children: ‘But, Mom, all the other kids have one,’” he wrote.

Similarly, former Federal Reserve chairman Paul Volcker called it the “Lake Wobegon syndrome” in congressional testimony in 2008, referring to Garrison Keillor’s fictional town where “all the children are above average.”

The practice has persisted because corporate board members, many of whom have personal or business relationships with the chief executive, have been unwilling to abandon the practice.

This is just another example of how "free enterprise" in the U.S. is badly distorted by systemic problems in how wealth ends up where it ends up.

[Lux Interior]

It's a small, incestuous group (i.e. old boys club).

The board members are CEOs of other companies and they are voting on the pay of a CEO who may sit on their board, or, if not their board, one not too far separated from theirs. Less separation than Kevin Bacon, a least.

Just a big circle-jerk.

[the_poochies]

Don't you know that if you reign in executive compensation, companies won't be able to attract top talent!





















Yeah, right.

[JoeH]

This keeps being reported, but so far just does not seem to caught the attention of those who could effect change. The boards are supposed to representing the interests of all stockholders, but as reported they are basing decisions on pay on more personal interests.

Unfortunately the same flawed decision making on executive salaries is also becoming prevalent in other areas such as non-profits and higher education. Salary inflation for the top level executives is as bad as in American corporations.

[cbelt3]

This is not a surprise to anyone. And it's up to the BOARD to take care of this issue, and the stockholders to get the Board to 'do it right'. And yes, it's been going on for years. The use of 'retention bonuses' is extra-egregious.. like these schlubs can somehow skip from one corporation to another ?

All the more reason to grow your own corporate officers and not bring in outsiders. The outsiders want more money, and perpetuate the system.

IMHO, it's another symptom of MBA-Disease. I'd much rather the "Business Schools" just be honest, and hand out letters of marque, tricornered hats, cutlasses, and black flags featuring the skull and crossbones.

[Acer]

"Government can't do anything right! A businessman would not stand for government waste and fraud! We should look to private industry to lead the way to prosperity for all!"

Pfft. My conservative family sits around the thanksgiving table grousing about the government. When that conversation runs out of steam, what do they grouse about next? THEIR own non-government employers and the utterly stupid decisions, practices and treatment of employees they have to deal with in their jobs.

How many people nod their heads in empathy when they read Dilbert?

[Mac1337]

Brezhnev worked for free.

[cbelt3]

http://en.wikipedia.org/wiki/Non_sequitur

"Non sequitur is Latin for "it does not follow." It is most often used as a noun to describe illogical statements."

[Mac1337]

Where is the apology?

[DaveS]

Ted King wrote:
http://www.washingtonpost.com/business/e...print.html

As the board of Amgen convened at the company’s headquarters in March, chief executive Kevin W. Sharer seemed an unlikely candidate for a raise.

Shareholders at the company, one of the nation’s largest biotech firms, had lost 3 percent on their investment in 2010 and 7 percent over the past five years. The company had been forced to close or shrink plants, trimming the workforce from 20,100 to 17,400. And Sharer, a 63-year-old former Navy engineer, was already earning lots of money — about $15 million in the previous year, plus such perks as two corporate jets.

The board decided to give Sharer more. It boosted his compensation to $21 million annually, a 37 percent increase, according to the company reports.

Why?

The company board agreed to pay Sharer more than most chief executives in the industry — with a compensation “value closer to the 75th percentile of the peer group,” according to a 2011 regulatory filing.

This is how it’s done in corporate America. At Amgen and at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.

The idea behind setting executive pay this way, known as “peer benchmarking,” is to keep talented bosses from leaving.

But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the “Lake Wobegon” effect.

It wasn’t until recently, however, that its pervasiveness and impact on executive pay became clear. Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Since then, researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.

Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her “peers” earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.

“Peer benchmarking has a significant influence on CEO pay,” Bizjak said. “Basically, you can’t have every CEO paid above average without pay ratcheting upward over time.”

‘All the other kids have one’

The gap between what workers and top executives make helps explain why income inequality in the United States is reaching levels unseen since the Great Depression.

Since the 1970s, median pay for executives at the nation’s largest companies has more than quadrupled, even after adjusting for inflation, according to researchers. Over the same period, pay for a typical non-supervisory worker has dropped more than 10 percent, according to Bureau of Labor statistics.

Critical to executive pay levels is peer benchmarking.

Even before the extent of the practice was known, it drew criticism from prominent business figures. After the Enron scandals, a blue-ribbon committee led by Peter G. Peterson, then chairman of the Federal Reserve Bank of New York, and John Snow, former chairman of the Business Roundtable, called for setting executive pay “unconstrained by median compensation statistics.” Legendary investor Warren Buffett, in one of his famously plain-spoken letters to investors, likewise derided the method.

“Outlandish ‘goodies’ are showered upon CEOs simply because of a corporate version of the argument we all used when children: ‘But, Mom, all the other kids have one,’” he wrote.

Similarly, former Federal Reserve chairman Paul Volcker called it the “Lake Wobegon syndrome” in congressional testimony in 2008, referring to Garrison Keillor’s fictional town where “all the children are above average.”

The practice has persisted because corporate board members, many of whom have personal or business relationships with the chief executive, have been unwilling to abandon the practice.

This is just another example of how "free enterprise" in the U.S. is badly distorted by systemic problems in how wealth ends up where it ends up.

Interestingly the same basic "methodology" is used for many corporate positions (engineers, scientists, high end office professionals, designers, coders, etc.) when deciding what to pay someone versus the competition. It ain't just in the board room BTW... you just saw the Unions using some of the same methodologies when negotiating the new Big 3 contracts.

Heck when you think about it - it's actually what happened in many real estate markets where buyers decided to pay premiums over and beyond asking prices.

This is not to say that the system isn't flawed to some extent. But that's the mathematics behind the system. It also opens up the question of 'Is this a facet as to why America labor is "overpriced" in the world market?"

And cbelt3 has it about right - it's actually the Board(s) or the "buyers" that is the real problem.