The Advisors' Blog

– Mark Van Clieaf, MVC Associates International

I recently saw Dave Lynn’s response to a query on this site’s Q&A Forum regarding how frequently must boards look at peer group survey data (particularly smaller companies who can’t afford it). Dave gave a great answer contrasting surveys and internal pay equity checks.

It’s important to note that internal pay equity checks are far less expensive than the flawed and distorted compensation surveys. I prefer internal pay checks that take into account a wide range of employees, from the front line manager to the CEO. I believe this is a great sanity and reasonableness check on CEO compensation fairness and we suggest this to our board and management clients. A check that can be used by anyone.

Here is an example of how this can work – let’s assume an internal pay equity multiplier of 2.52 with these additional facts:

– Average front line worker = $30,000

– Highest paid front line manager = $ 118,000

– Director of business unit – 2.52x multiplier

– VP/SVP of business unit – 6.35x multiplier

– Business Unit President – 16x multiplier

– Group CEO – 40.33x multiplier

– Global CEO – 101x multiplier (which results in annual total pay of $11.3 million)

So in this example, there are six value-adding management layers that results in the CEO’s pay being 376 times that of the front line worker or 101 times that of the front line manager. Many believe that this is excessive pay. That is true for many companies, but not all. It depends on the complexity of the CEO role and the number of value adding management layers in the enterprise.

One of the keys here is that each management layer adds unique value. Based on 30+ years of research, we know that the “Felt Fair Pay” multiplier between each value adding management layer (i.e. Work Level) is in the 2.0- 2.5x range. Some companies are overlayered so you can’t just take the number of layers and multiply each by 2.52x to get to the “Felt Fair Pay” pay differential.

To be able to ascertain what is truly fair, I use this “Felt Fair Pay” model of internal pay equity that looks at whether the task being performed are truly different and more importantly, whether the performance metrics, performance periods and decision rights identify the differential work in a role across the company’s management structure. You want to ensure you build up to the CEO’s pay multiplier from the front-line manager compensation by not just checking the CEO’s pay to the 2nd tier of management pay differential.

This all can be a little confusing when you first hear about these methodologies, so I recommend you look at my presentation from last year’s “4th Annual Executive Compensation Conference” (video archive is still up). You may also want to review this article I wrote on the topic (and this article too). This provides a great sanity and reasonableness check for boards so that they don’t get caught up in the flawed compensation surveys and wind up with pay chasing pay.