Kevin Kuschel, Managing Director

In today’s talent market, a competitive compensation package is critical to attracting and retaining the best people. But do you truly know if your compensation is competitive across organizational types?

While public peer groups are not required for private company compensation analyses, they can be valuable tools for benchmarking and ensuring your organization’s compensation arrangements are competitive and aligned with industry norms. This article dives into key considerations, benefits and limitations regarding the use of public peer groups. But first, let’s look at how this practice came about.

Some Background for Context

About a decade ago, a slow convergence of executive compensation practices within similarly sized mid-market public and private companies began. The genesis of this practice alignment came from the realization that talent pools were not restricted to one type of organization. Rather, private companies concluded that efforts should be made to find the best candidates across all types of organizations. Public companies did the same. The result of this battle: Private companies largely failed to win the talent war. But why?

Historically, private companies held an overly myopic view of compensation. They lacked creativity and limited vehicle usage. More to the point, they paid much less and offered too little diversification. This was detrimental to their efforts to persuade talent at public companies to make the jump to private companies. Sure, they were able to pitch greater flexibility, less oversight and potentially greater upside, but ultimately it was usually deemed a less lucrative proposition.

As of the last few years, though, the shift accelerated, resulting in the beginning of a sea change. More private companies, realizing they were at a competitive disadvantage, began to assess what public companies were doing and how they could begin to better align pay packages and pay at more competitive levels.

Enter the Public Peer Group

This involved, first, identifying where disparities were greatest and what actions could be taken to improve their structures. The process began with instituting a greater reliance on the use of public peers to compare compensation. Again, while public peer groups are not necessary, ignoring their relevance will place a private company at a distinct disadvantage to private competitors using public peers, as well as the public peers themselves.

Here are some key considerations and benefits regarding the use of public peer groups in private company compensation analyses:

• Benchmarking Compensation Public company peer groups provide a basis for comparing compensation levels and practices with similar companies in the same or similar industry or region. This can help private companies assess whether their compensation packages for executives, directors or other key employees are competitive and appropriate.Since 2010, CEO compensation in private companies has increased by an average of 5% annually. Seeing the need to follow public counterparts more closely, private company boards began the process of changing compensation philosophies and increasing compensation levels to ensure the competitive landscape for executive talent remained as level as possible.With this increase in compensation value also came changes in compensation structure. Historically, private companies focused on shorter-term components like base salary and short-term incentives. While long-term incentives were present in some cases, they were by no means highly prevalent and certainly lower in value than the cash-based components.The rebalancing of components has resulted in a greater utilization of long-term incentives for private company executives. Guided by philosophical compensation approaches and sometimes limited by bylaws, these have taken on multiple forms, including equity, synthetic equity, retention plans, deferred compensation and long-term performance cash. Regardless of the specifics, the influence of public companies on private company compensation programs is undeniable.
• Identifying Market Trends Peer groups allow companies to identify market trends and best practices in compensation, such as prevailing salary levels, incentive structures and benefits offerings. This information can inform decision-making and help companies stay competitive in attracting and retaining talent within a specific market. Sometimes, knowing what a specific competitor is doing is of greater value than general market practices.Information gleaned from peer company disclosures may often validate current structures or could result in determining the need for changes. As described above, trends at public companies have a direct impact on how private companies view compensation and potentially how they approach adjustments.
• Demonstrating Reasonableness In certain situations, such as when determining executive compensation for tax or regulatory purposes, private companies may be required to demonstrate that their compensation arrangements are reasonable. Benchmarking against peer companies can help do this.When compared only against other private companies, the data is sometimes skewed lower (depending on sources) and can provide false perceptions of actual alignment to market. The introduction of public company data provides a more fulsome picture and an actual depiction of relative alignment.
• Providing Context for Shareholders & Stakeholders Peer group data can provide context for shareholders, investors and other stakeholders who may be interested in understanding the company's compensation practices and how they compare to industry norms.With increasing scrutiny of compensation practices, investors and other stakeholders of private companies have started to get more involved in the compensation process. While many of these stakeholders do not have specific compensation decision-making authority, they do have influence. As such, greater transparency into compensation process and methodology creates greater trust and can limit negative reactions to compensation decisions.

Limitations & Challenges

There are also limitations and challenges associated with using peer groups for private company compensation analyses that must be considered, including:

• Limited Availability of Data Private companies may have limited access to comprehensive and reliable data, especially for smaller or niche industries where benchmarking data may be scarce due to a lack of public peers in that particular market. Often, it comes down to the identification of tangential industries where a company competes for talent and where executive skills sets make them prime targets. This may not mean a direct industry match but rather a good comparator for other reasons.
• Lack of Comparability Finding true peers for benchmarking purposes can be challenging, as private companies may vary widely in terms of size, industry focus, geographic location, ownership structure and other factors that can affect compensation practices.Further, many stakeholders may view the inclusion of public compensation data as a means for simply increasing compensation. The use of public peers is a sensitive issue that needs education and careful selection. Once the rationale is effectively communicated, this often reduces concern.
• Customization Needs Private companies may have unique business models, strategies and organizational cultures that require customized compensation approaches rather than simply replicating industry norms. This is why data is often used to inform decisions, not dictate them. This is true whether the data is from private or public companies and why receiving expert guidance is often necessary to ensure all angles and impacts are explored.