Understanding Compensation Peer Groups

February 2024

The Role of Compensation Peer Groups

A compensation peer group serves as a sample of the talent market relevant to a business, providing a reference for determining target pay opportunities within the organization. Unlike performance peer groups, which provide a benchmark for assessing value creation, compensation peer groups offer insights into the competitive talent landscape, aiding management teams and boards in making informed pay decisions.

Guiding Principles for Establishing Peer Groups

To establish a compensation peer group, it's crucial to identify guiding principles. These principles may include factors such as the targeted skill set of management (e.g., public company experience, start-up expertise, operational or M&A focus). Using these principles, the next step involves screening the market for potential pay peers based on criteria like company size, industry, and geography.

Screening Criteria and Considerations

Company size is a pivotal factor, with various metrics such as Enterprise Value, market capitalization, revenues, and EBITDA considered for comparison. The objective, assuming a pay philosophy targeting the median, is to position the business near the median of the peer group across relevant size metrics.

Industry and geography are also vital considerations. Pay practices can vary across sectors, and the location of operations and personnel may differ. A careful analysis of where talent could be sourced, including considerations of regional pay differences, is essential.

Casting a Broad Net and Refining Peers

When screening for potential peers, casting a broad net initially is recommended. While an ideal peer group might consist of companies between ½ and 2x the size of the business, an initial screen may use a broader range (e.g., sizing of ¼ to 4x). Refining potential peers involves considering the complexity of the business, growth prospects, and ownership structure.

Balancing Focus and Robust Data Set

Developing a compensation peer group often involves a trade-off between focused, operationally similar companies and a robust data set. Judgement, informed by guiding principles, is always necessary.  A peer group should ideally consist of 10 - 15 companies to generate a meaningful data set. If closely comparable peers are challenging to identify, a hierarchy of desirable characteristics can guide the inclusion of additional comparators.

Navigating Complexity with Hugessen Consulting

Hugessen Consulting specializes in assisting clients across various industries in navigating the complexities of developing compensation peer groups. This process, though time-consuming and potentially contested, help ensure a defensible approach that all stakeholders can endorse. It requires open and transparent discussions, guided by both objective criteria and subjective qualitative considerations.

In conclusion, while a perfect peer group may not exist for every business, achieving a balance between direct comparables and a robust sample of the talent market is key. Hugessen Consulting collaborates with management teams and boards to arrive at solutions that align with the unique characteristics of each business.