A Method for Benchmarking Internal Equity
As compensation professionals working with executive pay, we commonly find ourselves thinking about equity. It is part of the job to consider how vehicles like stock options, restricted stock, and performance units are awarded to effectively retain and motivate the company’s leaders. However, there is another definition of “equity” worth considering. It ensures that the compensation structures we put into place are objective, do not result in large gaps between employees, and in-line with competitive practices (hint: this one doesn’t have to do with a company’s stock).
A company’s executive total target pay progression can be benchmarked to the external labor market in addition to the typical market pricing approach of matching your company's jobs to the salary survey benchmark jobs. While monitoring the pay progression between the company’s management and professional salary bands/grades is a common practice, we find that benchmarking pay rank at the upper executive level may be beneficial as well. Specifically, we find three applications for benchmarking executive pay progression.
- The Macro-level: Assessing pay progression of top executives as compared to similar companies (based on size and/or industry) may help determine if their pay gaps between executives are similar to those in the market. This knowledge can help inform compensation decisions ranging from how to spread merit budgets to how to differentiate incentives/leverage among certain executive populations.
- “Unique” Roles: Benchmarking a role that doesn’t neatly fall into a compensation survey’s predefined job descriptions (e.g. “our corporate affairs executive is also in charge of corporate strategy, but we value the role as the 11th highest in the organization”).
- Impact of Internal Outliers: Assessing how executives with above-market opportunities (e.g. succession planning premiums or inducements to join) impact the pay progression within the entire organization is often insightful. On the other hand, if the CEO is provided above-market opportunities, benchmarking pay progression can help companies walk the line between a wide pay gap between CEO and his/her executive team, and a shifting structure incrementally “catching up” to the CEO and moving toward above market posture (and cost).
The graph bellow illustrates the pay progression of the 15 highest paid executives from 313 participants in Aon’s Total Compensation Measurement® (TCM) survey. Each executive is ranked by his/her total target annual compensation package and pay progression is measured as a percent of CEO pay, thereby removing the impact of differing compensation targets (on a dollar basis) among the CEOs in the sample. In other words, Aon would say that the competitive practice for total target pay for the second highest paid executive ranges from 32% to 47% of CEO total target pay, with the median being 39%. The bars in the graph below display the 25th, 50th, and 75th percentile values.
Interestingly, the graph clearly shows a dynamic in pay progression among top executives; that at the upper levels of executive ranks we see a diversity of pay practices (as illustrated by the green and blue bands), but at the 9th highest paid executive the competitive range narrows significantly and the median becomes less spaced out, illustrating more of a convergence of pay practices. At these lower levels, it suggests that most companies are less likely to differentiate pay between executives.
For those who would rather just look at the numbers, the table below shows the detail used in the graphic above. It also adds another dynamic on reporting relationships within each of the pay ranks. Looking at reporting relationships sheds light on the structures summarized in the statistics. For example, it is no coincidence that the 9th highest paid executive is when the competitive range between the 25th and 75th percentile begins to narrow, as this is also the first point in the progression where the majority of executives do not report directly to the CEO and further refines what the graph above tells us—that companies incorporate a wider range of practices in compensating the CEO’s direct reports as compared to the the next level of executives.
Aon’s executive compensation consultants are able to help companies benchmark their internal pay progression. Contact us for more information on how to conduct these analyses and how it may be incorporated into your compensation planning and benchmarking.