Compensation Benchmarking, Leapfrogs, and the Surge in Executive Pay (Subscription or fee required.)
Thomas A. DiPrete (Columbia University), Greg Eirich (Columbia University), and Matthew Pittinsky (Arizona State University)
American Journal of Sociology, vol. 115, no. 6
The salaries of CEOs have skyrocketed over the past 20 years, rising at a faster pace than average wages, managerial pay, or corporate earnings. This paper finds that compensation benchmarking is the reason. A standard practice in many industries, benchmarking occurs when compensation committees use peer executives at rival firms to establish a “fair” market wage. The problem is that each year, some CEOs leapfrog others by raking in huge bonuses or raises that are unrelated to their company’s performance, often thanks to poor corporate governance or oversight. These inflated salaries are then used by other companies to set their compensation levels; over time, the snowball effect makes CEOs’ salaries swell dramatically. In a sense, the authors contend, firms are punished when their competitors don’t rein in executive pay.
The researchers reviewed Standard & Poor’s annual compensation surveys from 1992 to 2006 for evidence of sharp increases in CEO salaries and then assessed individual chief executive pay hikes against compensation packages received by executive peers. They also examined how CEO pay was determined by analyzing consultant and compensation committee records. Leapfrogging accounted for about half of the overall increase in CEO salaries in that time period, according to the authors. The mean CEO salary plus bonus, adjusted for inflation, grew by 58 percent from 1993 to 2005, and the mean total compensation, which included stock and stock options, increased by 116 percent. Meanwhile, mean annual compensation in the United States overall rose by only 15 percent.
In 2006, the U.S. Securities and Exchange Commission mandated that firms disclose whether and how they use compensation benchmarking. This should enable shareholders and researchers to more easily determine whether a CEO pay package at their company or at any other in the industry has been inorganically boosted by one or a few leapfroggers.
A primary reason for the surge in CEO pay over the past 20 years is compensation benchmarking, in which companies use the salaries of competitors to help determine their own chief executive’s wages. This means inflated salaries can artificially drive up compensation.