The issue of whether compensation consultants are providing independent advice to their corporate clients has garnered a good deal of attention lately. Two recent studies reach conclusions that should give Board Compensation Committees some pause when hiring a consultant but also, indirectly, highlight the much more general and illusive issue of "professional independence".
Henry Waxman's House Committee on Oversight issued a report in late 2007 that found that:
There appears to be a correlation between the extent of a consultant’s conflict of interest and the level of CEO pay. In 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interest was 67% higher than the median CEO salary of the companies that did not use conflicted consultants. Over the period between 2002 and 2006, the Fortune 250 companies that hired compensation consultants with the largest conflicts increased CEO pay over twice as fast as the companies that did not use conflicted consultants."The Role and Effect of Compensation Consultants on CEO Pay", A study by two Wharton Professors, Mary Ellen Carter and Brian Cadman, had related but somewhat different conclusions. They found that a) executives get paid more when compensation consultants are involved but b) the pay is still as equally sensitive to pay-for-performance variability as those companies who do not use a compensation consultant and c) there is some, but not conclusive evidence that "conflicts of interest" among compensation consultants influences the magnitude of executive compensation.
The Waxman report defines a "conflict of interest" as when a consulting firm that provides executive compensation advice receives a significant amount of revenue from the same client for non-executive compensation consulting services. A not-atypical example would be a consulting firm that provides executive compensation consulting services to the Compensation Committee for 100k a year and is also hired by the company's management to provide $10 million a year in administration, brokerage and actuarial services on behalf of the employee benefits program.
The Wharton study defines conflicts similarly but did not have access to the same consulting firm revenue as the subpoena-empowered congressional committee.
As a consultant that often provides executive compensation advice, I would like to be able to punch holes in the data but in this case it is not lying. The data clearly shows that, after adjusting for other factors, companies that hire compensation consultants pay more to their executives than those that do not use consultants. I am also persuaded by the data from the Waxman committee that the more money companies pay to the firms that provide their executive compensation consulting services, whether for compensation or other consulting services, the higher their executives are paid. While the Wharton study does not firmly conclude this, they also did not have access to the detailed consulting firm revenue data as the Waxman Committee and were forced to rely purely on proxy data.
This is a serious issue that needs to be faced up to. But it is not a new issue nor does it begin and end with compensation consulting. Every professional, whether they be consultants, lawyers, accountants, brokers, or actuaries, that provides advice to a corporate client faces the uncomfortable fact numerous times throughout their careers that the folks who pay their bills (i.e., company management) might, at times, have a different agenda than their ultimate client - the shareholders. After all, even if you are a compensation consultant that does not have a conflict of interest as defined by the Waxman Report, you do not want to be fired from your consulting job for providing advice that the CEO doesn't like.
The best professionals - compensation consultants among them, face this reality head-on. They acknowledge the possibility that they may provide advice that the check writer does not like, and they are always prepared to walk away from a job. The best consulting firms support this independence. And, in my experience, what might surprise Waxman, et al. is that the most financially successful consultants are those who are data driven, daily work to provide "objective" advice whether it is welcome or not and are always prepared for the consequences of their actions whether it means having their firm loose a lucrative benefits administration contract or losing their engagement.
I would also add, that in my experience, corporate management usually works just as diligently with the compensation committees to develop solutions that are fair to executives and shareholders alike. But by its nature, fair is often in the eye of the beholder and, in a healthy relationship, there should be some tension between what management wants to receive and what shareholders through the Board wants to pay.
Maybe we need a little more tension in the board room. With respect to compensation consultants, I see Boards and management already swiftly moving in the direction of requiring independence from other revenue streams. But beyond that, we professionals need to continuously monitor our corporate relationships and remind ourselves of who is ultimately paying our bills.
