The market for executive pay is more efficient today than it was decades ago, a pay consultant insists.

RJ Bannister - Leader, North America executive compensation consulting, Willis Towers Watson

April 21, 2017 | CFO.com | US

Executive pay is just about right — for today, which assumes an efficient market. To suggest otherwise would imply that there is a market irregularity, such as a bubble or inefficiency, which causes an imbalance in executive pay.

RJ Bannister

I submit that the market for executive pay is more efficient today than it was 20, 50, or even 100 years ago, driven by three primary forces; more information, more scrutiny/attention, and more employment liquidity.

Let’s first discuss the issues of efficient markets and the influence of information. Markets are deemed to be efficient. Market clearing rates (MCRs) change with new information over time.

Executive pay is no different. Perceptions of the value or worth of an MCR will always exist, whether it’s the value of a teacher, a piece of art, an NBA superstar, or an executive’s pay. Any observer can have a perception about the value or worth of a MCR. However, most observers have limited or no influence on the MCR. Usually only decision makers have this authority.

New information over time creates an supply-and-demand imbalance in the decision makers and moves the market to a new MCR. Local counties and tax authorities (along with unions) determine teachers’ compensation, investors/collectors the price of a piece of art, and an NBA owner the compensation of a basketball star. For public companies, the decision makers who have the ultimate authority on executive pay are the company’s board of directors by way of the compensation committee.

Of course, many external forces and constituents can influence executive pay, including the supply and demand of executives themselves, shareholders, shareholder advocates, legislation, regulations, pundits, and, yes, consultants. These influencers provide new information over time, which helps adjust the MCR accordingly and revise perceptions, both positively and negatively.

Executives today are much more informed about pay levels than ever before. Public disclosure, search firms, and advocates (lawyers, tax advisors, private bankers, etc.) arm executives with more information on compensation MCRs and, thus, enable a better negotiating stance in an arms-length transaction.

The government has also played a critical role, by elevating the amount of scrutiny and effort involved in looking at executive pay. Take a look at companies’ proxy statements from just 25 years ago and compare them to today’s. The striking contrast points to the breadth and depth of the information U.S. public companies are now required to provide.

All of this information has raised the average investor’s consciousness of executive compensation, how much executives get paid, and how they receive that compensation.

Today, managing the Compensation Discussion and Analysis section of a public company’s proxy statement has become an essential part of the compensation committee’s purview. While the U.S. governance wave seems to have crested, management of a company’s annual compensation cycle has become a full-time job that can have a significant impact on the company’s success and reputation.

Finally, executives have more mobility today than ever before. Executives are likely to work for multiple firms over their careers, versus becoming a “lifer.” The continued decline of defined benefit retirement programs over the past 40 years and the reallocation of that money into total direct compensation have had a tremendous influence on the level of executive compensation and the increase in executive mobility. Executive search firms provide an active catalyst to inform executives of external opportunities and the potential compensation level.

It’s often difficult for observers to grasp the full import of a revolution when they are living it. All employees, not just executives, will likely benefit from increasing digitization and technology. These factors will also drive more information, more scrutiny/attention, and more liquidity to lower-level workers as well.

This will drive a platform for average workers (freedom of mobility, freelancing, the “gig” economy, personal branding, on-line job postings, etc.) to arm themselves with more information and hence a stronger bargaining position in the future.

RJ Bannister leads Willis Towers Watson’s executive compensation consulting practice in North America.

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Source: CFO.com

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