Congress Examining the Role of Compensation Consultants

by Matt Perkins

The House Committee on Oversight and Government Reform held a hearing yesterday to examine the role of compensation consultants in advising boards on CEO pay, and whether or not those consultants have conflicts of interest.

 

During the hearing, the committee’s Democratic Chairman Henry A. Waxman discussed a report his staff had composed over the last seven months, called Executive Pay: Conflicts of Interest Among Compensation Consultants.

 

Waxman explained that what he considers are high pay packages for CEOs could derive from the possible conflicts of interest on the part of compensation consultants that are hired by boards to advise on executive pay, and also by those same executives to consult on compensation inside the company and provide other services, according to his report.

Corporate governance experts, institutional investors, and compensation consulting firms testified regarding the role of consultants in settling CEO pay. They recommended ways to prevent and manage conflicts of interest as well as touching upon the adequacy of the information available to shareholders and the public.

“In the 1980s, the CEOs of the nation’s largest companies were paid 40 times more than the average employee,” Waxman said in his opening statement. “Now they make over 600 times more. At a typical company, 10 percent of corporate profits — a staggering sum — goes into the pockets of top executives. These huge pay packages raise a basic question: Are corporate CEOs working for the companies who hire them or are the companies working for the CEOs?”

 

Based on seven months of investigations by his staff of companies in the Fortune 250, the results of the report found that 113 of them received executive pay advice from consultants that were providing other services to the company.

“Consultants who are paid millions of dollars by a corporate CEO won’t provide objective advice to the board. They know what the CEO wants to hear and they know what will happen to their lucrative contracts if they don’t say it.” --Rep. Henry A. Waxman, House Committee on Oversight and Government Reform

What’s more, Waxman explained that on average, companies paid their consultants less than $200,000 for compensation advice, but paid them more then $2.3 million for other services. In one instance, a Fortune 250 company paid a consultant more than $11 million for other services in 2006, 70 times more than the company paid it for advice on executive pay.

 

“Consultants who are paid millions of dollars by a corporate CEO won’t provide objective advice to the board,” Waxman said in his opening statement at the hearing. ‘They know what the CEO wants to hear and they know what will happen to their lucrative contracts if they don’t say it.”

 

Members of the committee were split along party lines on the need for new rules on compensation consultants. Republicans on Waxman’s committee strongly opposed the hearing in the first place. “I find this hearing one of the most appalling, most embarrassing hearings I've ever had at this committee," said Rep. Mark Souder, an Indiana Republican.

The Republican members in general said the conflict-of-interest issue isn't something they should address legislatively, and democrats suggested that the topic be put before the Securities and Exchange Commission.

 

Charles Elson, the Edgar S. Woolard, Jr., Chair of John L. Weinberg Center for Corporate Governance at the University of Delaware’s Lerner College of Business & Economics, testified that pay unrelated to performance is the result of failure and effective bargaining between the board and management. Overreaching management and passive, management-dominated directors often advised by sometimes compromised compensation consultants are the elements that lead to this failure.

 

“The key to the solution is to stimulate better bargaining between board and management,” Elson testified. “This can be accomplished by insisting that the board, and particularly the members of the board’s compensation committee who negotiate with executives about pay, comprise individuals who are completely independent of management and hold personally meaningful equity stakes in the organization. This will ensure that they have the objectivity and incentive to effectively negotiate pay.”