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FOMO. Follow the leader. Keeping up with the Joneses. When it comes to peer pressure, companies are just like the rest of us.

So says Duke Law corporate and securities law professor Yaron Nili, whose new research finds that corporations look to their contemporaries on more aspects of governance than previously believed. While companies have long compared themselves with peers in deciding executive compensation, Nili discovered that influence extends to many other policies affecting how a company is run — with implications for corporate disclosure rules, investors, and shareholder advocacy.

“Corporations, or the people who run corporations, are just humans and they have social biases,” Nili says. “It’s a social sandbox.”

In a new paper, Peer Group Governance, published in the Harvard Business Law Review, Nili examines how companies designate peers and the role that plays in the practices they adopt. These practices — board gender diversity, board independence, proxy access, and others — spread through a number of channels, including pressure from directors, shareholders, institutional investors, proxy advisors, and regulatory agencies like the SEC.

Nili argues that the social channel of peer group comparison has been overlooked and is playing an influential role in disseminating governance practices.

“Peer groups may be created to justify executive compensation, but once they’re established they are more than that,” Nili said. “They are basically a reference point for a lot of other issues, including consideration of governance arrangements.”

Over the past couple of decades, as executive compensation became a topic of hot debate in the U.S., corporations began to benchmark themselves against companies they viewed as peers to justify executive pay packages, Nili explains. Companies are required by the SEC to disclose that in public materials. Peer group comparisons are also used to benchmark measures like share performance against other companies, he noted.

Nili started looking into broader peer group influence on companies after talking with a board member who made an interesting comment about looking to peers for guidance on governance practices.

“A lot of my research is focused on finding something that is hiding in plain sight and using data to expose it,” Nili said. “I was very curious to take this anecdotal insight and see if it was actually something that is more large scale.”

Nili collected and examined 17 years’ worth of data, spanning 2005 to 2021, on peer group designations by S&P 1500 companies to provide a detailed account of the use, attributes, and composition of peer groups. He then compared the governance characteristics of each corporation to corroborate what the data showed — the use of peer groups as a mechanism for transferring governance policies and practices — and confirmed the phenomenon through robustness tests to ensure that it wasn’t driven by other factors.

“I don’t claim to prove causality, but there are pretty strong empirical indications that support the notion that peer groups affect governance,” Nili said.

He also conducted qualitative research, interviewing board directors and general counsels to confirm that what the data show is actually happening in practice.

“I had a lot of interesting discussions with directors about how peer groups do affect governance decisions, and how they affect board discussions about various topics from diversity to ESG to answering regular governance questions,” he said.

Findings and implications

One interesting finding is that many companies don’t necessarily choose firms in the same industry, with a similar size and market value, as their peers. Rather, they may designate much larger and more successful companies.

“There’s an aspirational element. If you’re a smaller fish, you want to tell your investors that you’re playing in the big leagues,” Nili explained. “A second, slightly more cynical, aspect is that larger companies tend to pay more to their executives, so to the extent that you put a few larger companies in your peer group, it makes it easier to justify a higher compensation for your CEO.”

Smaller companies may also select bigger competitors in their industry as peers simply by virtue of operating in the same space. When companies do mutually designate each other as peers, Nili shows, there’s a reciprocity effect, or a stronger correlation in governance between the two.

“There’s a stronger behavioral connection because both companies relate to each other as peers and it’s not one-sided,” he said. “The results are stronger when you look at reciprocal-type peers as far as governance changes, which strengthens the argument about the impact.”

Peer designations also tend to become “stickier” over time, he says. Companies want to avoid arousing investor suspicion that they are trying to move the goalposts by choosing a new set of benchmarks.

“Once you designate peers, they stay your peers for the duration unless you have really good reasons to drop them,” Nili said. “You may pick a company because of executive compensation, and if they make a governance change, you’re kind of stuck with it or you’ll need to explain to your investors why they did it and you didn’t. It generates this internal incentive to try to conform, or at least not be too much on the outside.”

Nili says his paper aims to introduce peer designation as a formerly hidden channel of governance diffusion that invites further examination into how it operates in practice and interacts with other governance channels, including regulatory mandates. Investors can treat a company’s use of peer groups as a governance tool to compare it with similar firms and gain insight into how its strategy may evolve, he says.

And regulators could improve transparency into the phenomenon by requiring clear disclosure in public filings of how peer groups are selected and used in governance decisions, just as they must disclose use of peer groups in compensation decisions, to create a more complete picture for shareholders of how decisions are made.

“If the SEC made a rule that asks companies to disclose governance peers, that would go a long way,” he said.