Corporate Governance

House Report Identifies Widespread Conflicts of Interest Among Corporate Compensation Consultants

By Jim Hodgson

The Committee on Oversight and Government Reform, chaired by Representative Henry Waxman, just released a report, ?Executive Pay:  Conflicts of Interest Among Compensation Consultants.?  The report begins by acknowledging the obvious fact that consultants to corporations face a financial conflict of interest should they provide both executive compensation advice and other services to the same company.  Citing one potential conflict, the report suggests that a consulting firm retained to administer a company?s employee benefit plan would be unable to provide objective advice on the compensation of the same executives that retained the consultants.

Broadly, Representative Waxman?s report finds that ?compensation consultant conflicts of interest are widespread.?  Last year saw more than 100 large public companies retain compensation consultants with significant financial conflicts of interest -- conflicts like the one just described, or worse.  ?In many cases, the consultants who are advising on executive pay are simultaneously receiving millions of dollars from the corporate executives whose compensation they are supposed to assess.?

Several key findings of the report should be of particular concern to shareholders of publicly-traded corporations:

(i)  Conflicts of interest among compensation consultants are far more widespread than originally believed.  At least 113 of the Fortune 250 companies receive executive pay advice from conflicted consultants.

(ii)  Most corporations do not disclose such conflicts of interest (as they are required to do) in SEC filings.  The report?s findings indicate that, in dozens of instances, corporations that retain conflicted compensation consultants report that such consultants are ?independent.?

(iii)  Within conflict-of-interest situations, fees paid to consultants for other services routinely dwarf executive compensation consulting fees -- by roughly 11 times on average at the 113 Fortune 250 corporations previously mentioned.  Such conflicted consulting firms thus have little financial incentive to retain even a modicum of ?independence? when reviewing executive compensation.

And, perhaps most disturbing:

(iv)  There is a demonstrable correlation between the extent of a consultant?s conflict of interest and the level of CEO pay.  On average, the CEO of a Fortune 250 company that utilizes the services of a conflicted compensation consultant can expect to earn 67% more than a similarly-situated CEO whose company does not use such a conflicted consultant.

It should come as no surprise, then, that along with the release of Representative Waxman?s report, the Committee on Oversight and Government Reform held hearings on the role of compensation consultants.  Best practices, said one leading expert, call for ?the consultant advising the compensation committee to be hired exclusively by the committee and perform no other tasks for the company or its management.?

This sentiment certainly reflects the approach taken by the Sarbanes-Oxley Act with respect to outside company auditors; why should the philosophy adopted within a corporation with regard to executive pay be any different?  Perhaps, then, SEC rulemaking will head in this direction -- either to rules that demand consultant independence or at least to the legitimate policing of companies that fail to make honest disclosure of truly conflicted compensation consultants.

Full post as published by PomTalk on December 20, 2007 (boomark / email).