Glass Lewis’ view on executive compensation is based on the premise that management’s primary duty is to maximize shareholder value and the performance of the company. In Glass Lewis’ opinion, compensation practices should align management’s interests with those of shareholders. Thus, Glass Lewis believes that executive compensation should be closely tied to company and stock performance.
We recognize that many of the factors that affect a given company’s performance will also affect the rest of the industry. Therefore, we believe executive compensation should be closely tied not to absolute or overall performance but rather to the company’s track record of performance relative to its peers. That is, management should be especially rewarded for directing the company in a manner that outperforms its peers.
Our model evaluates five indicators of shareholder wealth and business performance. For the majority of sectors, these five metrics are: (i) change in operating cash flow; (ii) EPS growth; (iii) total shareholder return; (iv) return on equity; and (v) return on assets. Change in operating cash flow is replaced with: (i) tangible book value per share growth for companies in the Banks, Diversified Financials and Insurance sectors; and (ii) growth in funds from operations for REITs, with the exception of Mortgage and Specialized REITs.
This relationship between relative executive compensation and relative performance is the basis of Glass Lewis’ proprietary pay-for-performance model. Our model evaluates the compensation of the top five executives by benchmarking that compensation against the compensation of the top five officers at peer companies. The model then compares the company’s performance to that of those same peers. In comparing the outcome of these analyses, Glass Lewis is able to evaluate whether the company’s executives have been paid in line with the company’s relative performance.
Peer group selection is a critical and highly scrutinized segment of executive compensation analysis today.
Equilar uses a method of peer group development based directly on market data and social analytics. Glass Lewis utilizes the Equilar peer group as an invaluable monomer in its proprietary pay-for-performance model.
Equilar has created a methodology for creating peer groups that solves the one-size-fits-all dilemma. Based on the disclosed peer groups of the company, this flexible process creates the most logical peer groups by using the disclosed peers of the entire Russell 3000.
Using analytics and algorithms proven in the social networking space, Equilar Insight generates an interconnected network of peer companies consisting of “who you know” and “who knows you.” Equilar Market Peers evaluates the strength of these relationships (one-way vs. reciprocal connections) and creates a list of the strongest connections.
Peer Selection Process
By bringing together peer group disclosure for thousands of public companies coupled with proven analytics from the social networking space, we believe this approach best models market choices. The results are pivotal for assessing and developing more accurate and sound peer benchmarking groups.
SEC regulations require companies to list firms compared for executive compensation benchmarking. Equilar uses this disclosed company relationship information to build a peer network.
The peer network consists of companies and their disclosed peer connections. The Equilar algorithm extracts this information to identify the strength of relationships between two companies. The stronger the correlation, the higher the peer is ranked.
By looking directly at market data, this approach avoids the limitations of arbitrary financial cut-offs or discrete industry groupings and better represents the complex relationships that exist in a competitive marketplace.
Equilar updates its market-based peers in January and July. The market-based peer data is based on publicly-disclosed information, as well as information provided to Equilar via its portal during its open submission periods. Glass Lewis may exclude certain market-based peers from a company’s pay for performance analysis if the peer falls into one or more of the following categories:
- Has less than two years of trading history from the most recent fiscal year end;
- Has been privatized, acquired or delisted;
- Is a non-US company or foreign private issuer;
- Does not have two full years of compensation data that aligns with the years that it has been publicly traded;
- Has changed the company’s fiscal year end, such that the consistency of the financials used to calculate growth rates would be impacted;
- Has experienced M&A transactions that would impact the consistency of the financials used to calculate growth rates.
Grading Pay for Performance
The model calculates a weighted-average executive compensation percentile and a weighted-average performance percentile. These two percentile rankings are compared to determine how closely the compensation tracks the relative performance of the company.
The companies with the largest “gap” can be identified as companies that have done a poor job of linking compensation with performance, and depending on the magnitude of the gap, each company is assigned a school-letter grade: “A”, “B”, “F”, etc.
If you have additional questions regarding the Glass Lewis P4P analysis, please contact us at firstname.lastname@example.org or visit our contact page.