from First Quarter 2010
Corporate Board Member
by Julie Connelly
Fury over excessive executive compensation is beating up on the pay consultants too. As part of its new rules on proxy disclosure and solicitation enhancements, the Securities and Exchange Commission has decreed that a company whose board retains a compensation consultant to advise its comp committee on executive pay must disclose all fees paid to this consultant if the same firm provides the company with other services, such as retirement-plan counseling. Moreover, if the board doesn’t have its own comp consultant but management does and uses it to advise on pay and other services as well, those fees must also be disclosed in the proxy. As James F. Reda, a New York City compensation consultant, points out, this disclosure isn’t quite as restrictive as Sarbanes-Oxley’s ban against audit firms’ providing non-audit services to their corporate clients. “Doing other business for the company when you consult on executive compensation hasn’t been outlawed,” he says. “It just has to be disclosed.” Still, there’s prospective fallout that could hurt the big consulting firms, and they’re not happy.
Compensation consultants come in two stripes. The big multi-line firms like Hewitt Associates, Mercer, and the soon-to-be-wedded Towers Perrin and Watson Wyatt provide an array of human-resources consulting services, including advising the board on executive compensation. The so-called independents, such as Fredric W. Cook, Pearl Meyer & Partners, and smaller firms like James F. Reda & Associates, deal only in executive compensation, and their primary focus is advising comp committees on CEO pay. Because the independents don’t offer any other services, companies are not required by the SEC to disclose their fees.
Compensation consultants commonly charge about $200,000 to $300,000 for their board advisory work but bill in the millions for their other business. Pension actuarial services, for example, can run to $5 million or more. “Executive compensation as an industry is small,” says Michael Kesner, a principal at Deloitte Consulting. “A fairly large practice might be $50 million in revenues, and the total universe is under $500 million, whereas revenues from broad-based consulting are in the billions.” According to a report issued in 2007 by the House Committee on Oversight and Government Reform, “The consultants providing both executive compensation advice and other services to Fortune 250 companies were paid almost 11 times more for providing other services than they were paid for providing executive compensation advice.” That discrepancy gives rise to the perception that to get more of this lucrative other business or to hang on to what they have, the multi-line consultants are encouraging compensation committees to overpay management. Or, as the House Committee report noted, “there appears to be a correlation between the extent of a consultant’s conflict of interest and the level of CEO pay.”
But is there? “At least five different academic papers that I know of started to look into the relationship, including one I decided to do myself,” says David Yermack, a professor of finance at New York University’s Stern School of Business. “But to the surprise of everybody, the research led nowhere.” In fact, Yermack never bothered to write up his results because he didn’t think there was any story to tell. “I was disappointed that nothing was found. I like a good scandal, but it doesn’t seem to be the case,” he says.
However, two of the three published studies did discover that CEO pay is higher when the company or the board uses a compensation consultant than when it doesn’t. The third, a paper written by Kevin Murphy and Tatiana Sandino, professors at the University of Southern California Marshall School of Business, turned up the interesting tidbit that CEOs are paid more if a consultant works exclusively for the board than if it works for management.
But there was little support for the thesis that the pay is higher when the consultant provides the company with other kinds of services. Only Murphy and Sandino’s research turned up what they called “modest” evidence that CEOs of U.S. companies received 7% more in total compensation when their consultants performed other services as well. By contrast, CEOs of Canadian companies with conflicted consultants got 40% more.
Continued...