Developing Compensation Peer Groups for Tax-Exempt Organizations

When considering the foundational elements of an effective and market-competitive executive compensation program, it’s critical to identify appropriate sources for gathering relevant pay data. 

One of the most common approaches is identifying a custom compensation peer group (or groups) composed of similar organizations. This peer group must be defensible and a reasonable representation of the competitive market for executive talent. Most often, relevant data on peers is drawn from Form 990 filings or insurance filings, allowing for detailed comparisons to executives at these named peers. In other cases, peers may be identified from existing surveys in which the survey provider can provide a “custom” cut specific to those peers included in their survey.

While developing an appropriate peer group is both an art and a science, this article outlines the key components of identifying appropriate peers and typical factors used to do so.

Why a Defensible Compensation Peer Group Matters 

To establish the rebuttable presumption of reasonableness under IRC Section 4958, a tax-exempt organization needs to rely on comparable market data,  which is often accomplished by using either an established peer group or survey data provided by an independent advisor, or both, when making executive pay decisions. The goal of developing a compensation peer group is to identify organizations that are comparable to your organization to not only ensure defensibility, but also to deliver reliable and relevant market compensation levels. 

In some cases, there will be many organizations that are comparable based on mission, operations, and size, leading to the primary issue of selecting the most appropriate peers from a considerable pool of comparables. In other cases, there are very few direct or clear comparables, which then requires greater judgment in identifying entities that are somewhat comparable and represent a reasonable competitive market for executives. 

Documenting Peer Group Development Factors

The parameters used to determine appropriate peers are predominantly governed by a compensation philosophy that supports effective governance. Participants in compensation programs also receive clarity on how the organization approaches pay decisions and how it benchmarks compensation against the market.

Core Metrics for Building a Compensation Peer Group

A peer group should consist of organizations that are truly comparable and appropriate for benchmarking executive pay, incentives, and other ancillary benefits. Whether a tax-exempt organization, a privately held company, or a publicly traded company, the key factors in developing a compensation peer group are generally similar:

• Organization Size (typically by operating expenses or revenue): Usually the single most important factor, as executive compensation levels are highly correlated with the size of an organization.
• Industry/Mission Similarity: Organizations should ideally operate in the same or similar space and compete for like talent.
• Complexity of Operations: Equal revenue does not always equal similar complexity.
• Talent Market: Peers may also be identified using a talent market approach, with peers chosen based on overlap of recruitment, shared executive talent pools, and similar leadership roles.
• Financial Health: Especially important in non-profit and tax-exempt benchmarking.
• Geographic Labor Market: While geography matters less for executive roles than lower-level positions, local market comparisons may still be a relevant consideration.

A Clear Process for Developing a Compensation Peer Group

Taking a structured approach to development helps organizations support good governance and provide transparency to program participants when considering pay decisions.

How to Ensure a Size-Appropriate Peer Group

Ideally, organizations will identify similar organizations that fall within a range of 0.5x to 2x revenue or annual budget. However, often that range needs to be expanded (e.g., 0.25x to 4x revenue or annual budget) in order to identify enough peers to gather reliable compensation data. 

In more rare cases, where there are not enough similarly-sized peers, a regression model can be used to “right-size” compensation levels of a peer group of organizations that are either too small or too large, from a size perspective, relative to your organization. This approach is more sophisticated and may be challenging to understand and articulate. 

Implementation Considerations and Practical Guidance 

Ensure that the peer group has continuous alignment with the organization’s compensation philosophy, regularly assess market comparability, and update as necessary to reflect any relevant changes in the organization (e.g., growth or diversification) or in the talent market.

As mentioned above, data gathered from a compensation peer group is often supplemented by data from other common sources of data, including relevant salary surveys, industry association surveys, and/or public company proxy statements (generally only for very large, complex tax-exempt organizations).

By following a structured process and committing to regular review, organizations can effectively establish a robust and defensible peer group with which to benchmark pay decisions.

The next piece in our Tax-Exempt Executive Compensation Essentials series will focus on evaluating the use of annual incentives.