By Contributor,IESE Business School,Virginia Tech

Copyright forbes

Thanks to the increased use of benchmarking, CEO salaries in the US are clustering around median pay levels.

When compensation committees sit down to set a CEO’s salary, a routine part of the process is to consider the pay levels of direct competitors – the chief executives of similar-sized companies in the same industry.

A large energy company will look at what the CEOs of other big power firms are earning; a mid-sized bank will gauge the salaries of executives of similar financial institutions. In fact, regulatory changes in the US over the last 20 years have encouraged this type of benchmarking, and CEO pay also draws increasing scrutiny from shareholders and proxy advisors.

As a result, CEO salaries are converging. Our research, forthcoming in the Journal of Finance, shows that CEO pay dispersion – the variation in pay across executives – has plunged almost 40% since 2006. CEO compensation is coalescing around median pay, with the distance at both the top and bottom of the pay distribution scale sharply diminished.

CEO pay dispersion in the United States from 1996 to 2023

Our research, conducted with Torsten Jochem of the University of Amsterdam and Anjana Rajamani of Erasmus University’s Rotterdam School of Management, is based on a wide sample of publicly listed US firms, from 1996 to 2023.

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And it’s not just in salaries that CEO pay is becoming more uniform: the same is happening to the structure of compensation contracts, according to separate research by Virginia Tech’s Felipe Cabezón. Since 2006, variety in salaries, bonuses, stock awards, options, non-equity incentives, pensions and other perks – the assorted potential elements of a CEO’s full compensation package – has fallen by about a quarter, Cabezón’s research finds.

In short, CEO pay is increasingly one-size-fits-all.

Why is CEO pay converging?

The data suggests the reason behind the convergence: the growing use of benchmarking against companies with a similar profile. CEO pay dispersion abruptly reversed course and began narrowing in 2007 – the year after the US Securities and Exchange Commission introduced a rule mandating public firms disclose the peer groups they used for compensation benchmarking.

The increased reliance on proxy advisors – the firms that provide information and voting recommendations to institutional investors – is another factor in CEO pay levels becoming more compressed. Many proxy advisors employ compensation benchmarking in making their recommendations to investors, and they also tend to offer homogeneous guidance across companies.

In addition, in 2011 the US introduced so-called say-on-pay regulations, which require publicly listed firms to regularly submit the compensation of their top executives to shareholders for an advisory vote. Firms are then required to disclose the voting outcome, and to respond to potential shareholder discontent. Again, this new rule has boosted transparency and accountability at the same time it nudged pay toward the middle.

It’s worth noting that outside of the top five executives in a firm, most of whom wouldn’t be subject to transparency rules, dispersion declined only slightly over the course of our study period. Additionally, the greater uniformity was seen only in publicly traded companies – the firms that are subject to SEC rules and where proxy advisors may be at work. The dispersion trajectory of private firms was entirely different, peaking in 2014 and 2018 before settling back to very similar levels as they were two decades ago.

Pros and cons of CEO pay convergence

While the pattern is clear, there’s no simple answer to whether CEO pay convergence is good or bad for companies and their shareholders.

More standardized criteria and greater transparency may make it easier to evaluate pay practices and promote accountability. Uniformity in pay setting may also enhance perceptions of fairness in CEO compensation design, a key concern for directors and investors. For large institutional investors, monitoring the individual compensation practices of all their portfolio companies may be complex and costly; benchmarking offers a simpler solution.

But at the same time, pressure from regulators and investors on CEO pay may lead boards to prioritize compliance over customization. As a result, firms may adopt a one-size-fits-all approach that fails to tailor to the specific needs of each firm and executive. That could undermine hiring and retention, and lead to weaker performance incentives and inefficiencies.

How CEO pay practices affect Europe

So far, this appears to be a mostly US phenomenon. Pay dispersion in Europe and the UK, for example, was much less drastic to begin with, and stayed largely unchanged over the study period.

But many countries and regions are considering variations on say-on-pay votes and enhanced disclosure requirements, at the same time they are attracting more institutional investors and proxy advisory firms. The European Union’s pay transparency directive, which members states must put into practice by June 2026, requires that employers disclose salary ranges in job advertisements, and gives current employees the right to request pay information for those performing similar work.

That means these trends could spread to other parts of the world, particularly Europe. Business practices become globalized and capital markets are increasingly interconnected. As firms compete for global talent and investors, executive compensation practices – and their unintended consequences – may cross borders.

By Gaizka Ormazabal, associate dean for Research and PhD program and professor in the Accounting and Control Department of IESE Business School.

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