How Executive Compensation Is Actually Set
The mechanism is benchmarking, and benchmarking has a well-documented ratchet built into it.
Executive pay at public companies is set by a compensation committee of the board, advised by a specialist consultant. The process is more standardised than most people assume, and its structure explains the pattern of outcomes better than any account based on individual greed.
The peer group
The committee selects a group of comparable companies — similar in industry, revenue and market value — and benchmarks pay against it.
Peer group construction is where most of the consequential decisions are made, and it is largely invisible. A peer group weighted toward larger companies produces higher targets for every element of pay, and the justification for including any given company is usually defensible in isolation.
The ratchet
Committees commonly target pay at or above the median of the peer group, on the reasoning that their executive is at least as good as the average.
If most committees do this, median pay rises every year by construction, with no change in performance anywhere. This is a well-documented and much-studied feature of the system, and it does not require anyone to act in bad faith.
The components
Pay is typically salary, an annual bonus against measured targets, and long-term equity that vests over years and often depends on performance conditions.
The long-term component is usually the largest, which is why reported pay figures vary so much between sources: some report the value granted, some the value actually realized when shares vested, and these can differ enormously.
Where boards have real discretion
The choice of performance measures matters more than the levels. Targets based on measures management can influence through accounting choices behave differently from targets based on cash generation or on performance relative to peers.
What to read
For any listed company, the compensation discussion and analysis in the annual proxy statement sets out the peer group, the measures, the targets and the outcomes. It is long, it is public, and almost nobody outside the industry reads it.