In today’s rapidly evolving and competitive market, companies face ever-increasing pressure to ensure they’re measuring themselves appropriately—not just in terms of what is being measured but also in terms of against whom comparisons are being made. It’s critical to not lose sight of the latter point; after all, some things just aren’t comparable. Mike Tyson and Manny Pacquiao are both former world champion boxers, but one was a 5’10”, 220-pound heavyweight while the other was a 5’5”, 145-pound welterweight. Both are legends in their own right, but there’s a reason each competed in his own weight class (peer group)

What Is a Peer Group?

Getting back to the business word, and that of compensation professionals in particular, we affectionately refer to the set of companies and organizations against which measurement is conducted a “peer group.” At its core, a peer group is a set of companies formed based on similarities in a number of areas, which can include size, industry, operational complexity, geographic scope, and other relevant factors.

Peer groups are one of the most effective tools for identifying trends, maintaining competitiveness, and demonstrating responsibility in the field of executive compensation.[1] With applications into other areas (for example, performance measurement), peer groups allow companies to benchmark themselves to ensure their practices are competitive, defensible, and aligned with market norms. Understanding how to construct and apply peer groups effectively can provide organizations with valuable insights into market positioning and governance alignment.

In the field of compensation, peer groups show up in various contexts, such as compensation benchmarking (e.g., setting salaries and incentive pay targets), incentive program design, long-term incentive pay outcomes (e.g., relative total shareholder return plans), governance best practices, and adjacent disciplines such as talent strategy and recruiting. Peer groups provide a snapshot of market practice and allow an organization to identify areas to maintain competitiveness and, if desired, differentiate itself from the pack. Using appropriate and robust peer groups in these contexts is critical so organizations can make informed decisions based on what is taking place in the market.

Another note before diving in—peer groups tend to include public companies due to their regular reporting of executive pay and financial results, and other benchmark data. While peer groups tend to be comprised of publicly traded companies, they have the ability to offer insights and provide utility to all organizations if properly constructed and maintained.

Design Considerations

Creating an effective peer group requires thoughtful assessment across both qualitative and quantitative factors:

• Size: The most obvious quantitative consideration is size, most often measured in terms of revenue. Studies have shown time and time again that revenue is the single strongest and most consistent predictor of executive compensation. There are situations in which it makes sense to consider other measures of size, such as market capitalization, enterprise value, assets, operating budget, and employee count. While there is not a universally accepted standard as to what constitutes too large or too small of a peer, it should be a goal of peer group construction for the median size of the peer group to be similar to that of the subject company.
• Industry: Aside from financials, it is also important to select potential peers that operate in the same or a similar industry. Depending on the space in which a company operates, this may be a challenge, or you may have ample companies to consider. When a company operates in a concentrated industry, or in circumstances in which a company provides a very unique product or service, it may be necessary to “zoom out” to identify potential peers in similar or adjacent industries.
• Additional Factors: Additional elements of potential peers to consider are the life cycle stage of the company, geographic scope, and ownership structure, among others.

Once constructed, an established peer group should ideally contain enough peers to provide a representative sample and endure some level of attrition as companies within it grow, shrink, or experience M&A activity. During the design process, compensation advisors can be an excellent resource to assist in tailoring a peer group that best fits your organization and intended purpose.

Ongoing Maintenance

It is recommended to revisit and, if necessary, update your peer group on an annual basis. This regular cadence is important because the financial performance (e.g., revenue growth) and strategic focus of companies within your peer group can shift year-to-year. In addition, market activity (such as M&A) can make a once-suitable peer no longer appropriate. Conversely, companies that were not previously peer group candidates may now be well-suited to be added to your peer group. Reviewing the peer group annually ensures it remains aligned with the company’s current market environment and strategic profile.

Conclusion

Whether your purpose is to benchmark pay levels, understand incentive plan trends, or identify specific best practices in any number of areas, a peer group can be an extremely effective and valuable tool. Undertaking a thoughtful and structured approach in design and building the review step into your annual process, if you have not already done so, are key to getting the most out of your peer group.