Attention around executive remuneration is usually focused on rocketing pay deals. Now researchers have unearthed a new phenomenon in the US: a dramatic fall in variation.

Academics from the Netherlands and Spain looked at 5,000 US companies over the past decade finding that chief executive pay deals have begun to cluster around the same levels regardless of the size or profitability of the firms involved.

The news comes as executive pay deals continue to be a bone of contention between boards and investors. Some executives took pay cuts during the pandemic while others did not. Recent research has revealed investors now want to see pay deals tied closely to ESG measures. According to Bloomberg, executives in struggling companies, including those dealing with Covid-imposed damage, can expect their pay arrangements to come under close scrutiny.

News that pay is also reducing in variation is bound to lead to investor concerns. But why is it happening?

Benchmarking pay deals

The researchers—Torsten Jochem, Gaizka Ormazabal and Anjana Rajamani—suggest that variation is disappearing because of the benchmarking used to set pay levels. They argue if firms all benchmark against each other, then set pay levels at a “common percentile”, variation in pay levels will almost certainly wane.

They offer three possible reasons why “reciprocal benchmarking” may be the guilty party.

Firstly, regulation forces disclosure of pay levels thus providing the comparative data needed to undertake benchmarking. The researchers found that pay variation starts to fall after the pay disclosure regime was introduced.

Another driver could be investor “say-on-pay” votes. Boards, they say, could react to the possibility of the reputational damage that might follow a negative response. “Boards,” they write, “may hence change compensation peer groups [for benchmarking] to address potential shareholder concerns.” The writers have a number of anecdotes supporting this theory but they also have a statistical model showing an increase in reciprocal benchmarking in the two years following a “weak” say-on-pay approval.

Lastly, the growth in passive investing and a reliance on proxy advisers may have also contributed. The writers point out that proxy advisers base their pay voting advice on their own benchmarking which may in turn cause boards to increase reciprocal benchmarking to avoid a clash.

‘A precipitous decline in pay diversity’

Further statistical analysis shows reciprocal benchmarking increases when company performance falls below “thresholds” set by proxy advisers.

Falling pay variation may be having other effects too. The researchers believe there is “strong evidence” that it may be related to declining promotion incentives (also called “tournament incentives”). This can affect firm performance. Equity returns are positively associated with pay variation, and negatively related to benchmarking.

Writing for the Harvard Law School governance blog, the academics conclude that their findings “document a precipitous decline in CEO pay level diversity among publicly listed US firms.

“We show that this trend is related to firms converging to a standardised practice of benchmarking CEO pay to firms in the same industry and size group.”

If the researchers are correct, there are considerable downsides to this phenomenon. Investor concerns over pay are bound to be further piqued.