How Companies Justify Big Pay Raises for CEOs
By Anders Melin Jeremy Scott Diamond | June 4, 2015

When deciding how much to pay their senior executives, the directors at Jarden Corp.—the owner of brands including Yankee Candle, Rawlings sports equipment, and Bicycle playing cards—use what might seem to be an unlikely measuring stick: the top managers at Oracle Corp., the world’s largest data-base maker.

Oracle is one of 14 companies Jarden identified in 2011 as a “peer”to help it gauge the going rate for executive pay—a common practice among boards when setting compensation for top managers. The idea is to survey businesses of similar type and size. In reality, it's not uncommon for companies to pick peers that are larger than themselves. Big jumps in executive pay sometimes follow.

Seven of the peer companies that Jarden disclosed in its most-recent proxy filing—including Oracle, eBay Inc., and Adobe Systems Inc.—had more than twice its market value at their 2014 fiscal year ends. Three of the peers posted more than twice its revenue. That exceeds what many compensation consultants consider the upper threshold for peer size.

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peer group used in 2011-2014 fiscal years
More than twice the sales revenue
More than twice the market cap

Circles sized by market capitalization as of companies' 2014 fiscal year ends

From 2011 to 2014, the combined compensation for Jarden's Chief Executive Officer James Lillie, Vice Chairman Ian Ashken, and Executive Chairman Martin Franklin increased more than sevenfold to $223.9 million, according to the Bloomberg Pay Index, a daily ranking of the highest-paid U.S. executives, which values pay as of a company's fiscal year end. The compensation includes salary, bonuses, perks, and equity awards.

Total Pay
Franklin, Lillie, and Ashken are among the top 30 highest-paid executives in the U.S., the index shows.

Circles sized by awarded pay

The same year Jarden began comparing itself to Oracle and eBay, the company dropped some of its previous peers, such as clothing-retailer Oxford Industries Inc. and vehicle-maker Thor Industries Inc.—companies that were smaller and paid their executives less.

Jarden Peer Groups
Average CEO awarded pay

Circles sized by CEO awarded pay

Shareholders need to know that peers are "not cherry-picked for the purpose of justifying or inflating pay," proxy advisory firm Glass Lewis & Co. wrote about Jarden in a May 2015 report to clients.

A spokeswoman for Jarden declined to comment. The peer group consists of “high-growth and high-performing companies reflective of the company's strategic objectives," the Boca Raton, Florida-based business said in its most-recent proxy filing.

Jarden isn't alone in picking bigger companies, or aspirational peers, for its group. The practice can be a way for corporations to signal the quality of their executives to investors, says Craig Ferrere, a former University of Delaware fellow who co-authored a 2012 paper on peer groups with finance professor Charles Elson.

“The use of aspirational peers is not a bad one, but one still has to be careful that they're justifiable based on the size,” says Steven Hall, founding partner and managing director of executive compensation consultant Steven Hall & Partners LLC.

The idea to survey pay at companies of comparable size was hatched in the 1950s by Milton Rock, then a compensation consultant at Hay Group, says Ferrere. As businesses began operating globally, the managerial skills needed to run them were largely the same. Rock argued executives had become participants in a “global exchange of talent,” Ferrere wrote.

By the 1990s, Rock’s peer group idea had become a go-to tool for boards, says the University of Delaware's Elson. In the Standard & Poor’s 100 Index, only Berkshire Hathaway Inc. and Kinder Morgan Inc. don’t use a peer group, according to proxies filed so far this year.

The influence of peer groups means one company's compensation decisions can affect pay at many others. Within the S&P 100 Index, Johnson & Johnson is the most popular peer, according to data compiled by Bloomberg. Almost half of the 88 companies in the index that have filed proxies for fiscal 2014 named the world's largest maker of health-care products as a peer.

Companies that put Johnson & Johnson in their 2014 Peer Group
These 42 corporation chose J&J as a peer; but the company only reciprocates with 14 of them.

Circles sized by market capitalization as of companies' 2014 fiscal year end

“If you went to J&J’s board and said: ‘Do you realize that what you pay your CEO impacts at least 42 other CEOs?’ I think they'd be surprised, ” Hall says. J&J spokesmen Ernie Knewitz and Amy Jo Meyer didn't respond to calls and e-mails seeking comment.

Take the case of Fabrizio Freda, head of Estee Lauder Cos. At the end of its 2010 fiscal year, the New York-based cosmetics maker added J&J, which produces more than seven times Estee Lauder’s revenue, to its peer group.

peer group used in 2011-2014 fiscal years
More than twice the sales revenue
More than twice the market cap

Circles sized by market capitalization as of companies' 2014 fiscal year ends

Freda's awarded pay has since topped J&J CEO Alex Gorsky's in two of the past four years, according to the Bloomberg Pay Index. J&J, based in New Brunswick, New Jersey, has never listed the skincare and fragrance company as a peer in proxy filings.

CEO Compensation
Fabrizio Freda (Estee Lauder) & Alex Gorsky (Johnson & Johnson)
$33.4M difference
$5.8M difference

Circles sized by awarded pay

Jill Marvin, a spokeswoman for Estee Lauder, declined to comment. Its compensation program is designed to “attract and retain high-quality people and to motivate them to achieve” the company's goals, according to its most-recent proxy filing.

Federal regulators have taken note of the potential influence of peer groups. In 2006, the U.S. Securities and Exchange Commission started requiring boards to disclose peer companies used to set executive pay. Five years later, it mandated public companies to hold non-binding advisory shareholder votes on executive compensation programs at their annual meetings. Those polls have made boards think more carefully about peer group selection, says Ann Yerger, executive director at the Council of Institutional Investors.

Jarden's investors are taking note, too. More than 40 percent of voting shareholders have rejected the company's compensation plan in three of its four most recent say-on-pay votes. Approval rates below 70 percent are generally considered “problematic” and should prompt directors to talk with shareholders to understand their concerns with the company's pay program, Yerger says.

Jarden is scheduled to hold its shareholder meeting in Miami today. Its board and compensation consultant Towers Watson & Co. said they will re-evaluate the peer group this year after receiving feedback from investors and proxy advisors, according to its April 20 proxy filing. Towers Watson declined to comment through spokesman Ed Emerman at Eagle Public Relations Inc.

Proxies filed last year showed that more than half of companies in the S&P 100 Index targeted compensation for their top managers at the 50th percentile or higher of their peer group's pay, according to data compiled by Bloomberg. If too many companies pay at median or more, compensation has nowhere to go but up, the University of Delaware's Ferrere said.

“There is definitely a ratcheting effect,” says Bill George, the former CEO of Medtronic Plc and a member of Exxon Mobil Corp.'s board of directors. “The consultants come in and say, ‘These are your peers,’ and nobody wants to be in that bottom quartile. We thought transparency would be good, the sunshine would be helpful. Instead it created a competition that's unhealthy.”