Non-Independent “Pay Pals” Get Pink Slips - Compensation Design Group - Aug. 14, 2007

Non-Independent “Pay Pals” Get Pink
Slips

Large companies are quickly ditching conflicted
executive compensation consulting firms for independent
counsel.

This week, Financial Week magazine reported that the Congressional
crackdown on executive compensation consultants with conflicts of interest has rapidly changed the industry landscape.

Many
of the country’s largest companies are now rushing to
hire independent consulting firms that specialize exclusively in
executive compensation, instead of retaining large consulting firms
that provide
other, often far more lucrative, consulting services, such as human
resources, actuarial, healthcare, pension and benefits plan
administration, in
addition to dispensing advice on executive pay. Many of those firms
provide insurance products to, and receive commissions from, the very
companies to
whom they are providing compensation consulting services. Some are even
owned by the insurance companies themselves.

The
extent of the change is stark.  According to a recent
Equilar analysis of Fortune 1000 proxy filings, 39% of compensation
committees now rely on independent consultants for advice on executive
pay,
compared with barely 30% in 2007. The remaining compensation consulting
arrangements are with “full-service” firms.

Similarly,
many other corporations are disclosing lengthy details
concerning their relationships with their existing compensation
consultants, in hopes of quashing concerns about possible conflicts of
interest that
sometimes arise when a consulting firm provides multiple types of
consulting services outside the executive pay arena.

These
changes are taking place at a time when both
presidential candidates, lawmakers, and shareholder activists have been
trumpeting the potential of very real conflicts to arise if an
executive
compensation consultant's firm performs non-related work for the same
client.
 
Indeed,
the Congressional Committee on Oversight and Government Reform, under
the leadership of Rep. Henry
Waxman (D-Calif.), released a highly critical report at the end of
2007, revealing that 113 of Fortune 250 companies retained “conflicted
consultants”—consultants that received, for example, $200,000 to
provide advice on executive pay, and yet more than $2 million to
provide consulting services in other areas. In the Committee’s well
publicized hearings last December, Rep. Waxman declared, “In effect,
the consultants are being asked to evaluate the worth of the executives
who hire them, and then pay their consulting firms millions of
dollars”. The system is intrinsically flawed. 

The Committee found that:

• 
  
  Human resources consulting firm conflicts of interest are
  pervasive;
  
  


• 
  
  The
  fees earned by human resources consulting firms for providing
  services other than executive compensation consulting services (e.g.,
  benefits, pension actuarial, healthcare, insurance, etc.) often far
  exceed those
  earned for advising on executive compensation;
  
  


• 
  
  Some
  human resources consulting firms received over $11
  million dollars in 2006 to provide services other than executive
  compensation consulting – in some cases, 50 to 70 times more than the
  client
  company paid the human resources consulting firm for executive pay
  consulting; and
  
  


• 
  
  Most of the companies scrutinized by the Committee did not
  disclose their human resources consulting firm’s conflicts of interest.
  
  

According
to the Committee, there appears to be a direct correlation
between the extent of the human resources consulting firm’s conflict of
interest and the level of CEO pay within the client company.

It
is no wonder many companies are going above and beyond to avoid
even the hint of such a conflict. Financial Week reported that
corporations such as Safeway and Verizon, for instance, have changed
their compensation
consultants to independent firms over the past year, pointed out Paul
Hodgson, senior research associate at the Corporate Library. “It's a
clear-cut way to send a message that you're intent on being
conflict-free,” Mr. Hodgson said. “It's an easy solution to something
that
could be a potentially sticky problem.”

“It's
an emerging trend to use an independent adviser in this
role,” said Melissa Plaisance, senior vice president of finance and
investor relations at Safeway, which generated more than $42 billion in
revenue last year. “We felt it was just an additional step in
maintaining a strong governance program.”

Because of this, independent executive compensation consulting firms
will continue to be in greater demand for their services.

For
instance, Pfizer, whose board has used an independent
compensation consultant since 2003, goes so far as to name its
consultant as a specific adviser in its proxy—while also itemizing each
of the
14 responsibilities he is charged with in his role, as well as the
specific projects he worked on for the company last year.

Pfizer
also volunteered to disclose the fees paid to their executive
pay consultant for these services. In 2007, the pharmaceutical company
paid $150,901 for consulting with its board on executive compensation
issues,
plus a fee of less than $5,000 for an executive compensation survey.

Pfizer
is hardly alone in deciding to disclose information about
fees paid to executive compensation consultants. While only a small
portion of companies actually offer this level of disclosure— only
about 3%
of companies revealed these fees in their proxies earlier this
year—that's triple the percentage of companies that did so in their
2007 proxy
filings, according to the Equilar proxy analysis. (The average fee for
these services was $161,691 last year, a 33% increase from the average
fee of
$121,183 one year prior.)

Such
disclosures appear to be even more detailed if a human
resources consulting firm also provides other advisory services to a
company. Consider Time Warner, which in its proxy filing earlier this
year
offered a seven-paragraph, 700-plus word description of the role of its
compensation consultant, Towers Perrin, which it attempted to
characterize as
“independent”. The company notes that its compensation committee has
used the firm as its independent executive compensation consultant
since 2002, outlines the work it did for the committee in 2007, and
also reveals the fees Time Warner paid for Towers Perrin executive
compensation
consulting services: $250,368 in 2007 and $263,885 in 2006.

However,
in the same section of the proxy, Time Warner notes that
Towers Perrin also provides the company with consulting and actuarial
services for its retirement plans, as well as consulting on its health
and
welfare programs for employees, and consulting on human resources
systems. For these services, Time Warner disclosed that it paid Towers
Perrin
roughly $2 million in aggregate fees for each of the last two years.
None of these fees, however, impact the compensation advice Towers
Perrin
provides to Time Warner, it states in the proxy, adding that the team
of compensation consultants do not work on any other consulting
assignments for
the company, and, they attempt to explain, that their own pay has
nothing to do with any of these other arrangements.

Compensation Design Group has always supported the
Committee’s conflict of interest views on human resources consulting firms that really do have entangled business relationships.

We
also believe that public company shareholders and board members
deserve higher standards of disclosure to verify the independence of
the executive compensation advice that their companies receive from
their
consulting firms. This disclosure will assist in curing the terribly
negative views that shareholders, employees, the media, and the
American public
have on executive pay.

The
Securities and Exchange Commission will likely require further
disclosure on compensation consultant independence. Current SEC rules
do not require tabular disclosure of fees for services provided by
human
resources consulting firms. This only fuels the flames of public
perception as well that the executive compensation consulting
profession is not
helping with, and perhaps even exacerbating problems with executive pay.

Diversified
human resources consulting firms, often owned by
insurance providers or public companies themselves, in fact have
significant economic incentives to provide ancillary services,
frequently far more
financially lucrative than the executive compensation consulting
services they provide. The executive compensation consultants of these
firms do,
however, have the ear of the board and senior management. That coupled
with cross selling of ancillary services, along with the realization of
significant fees, creates a recipe for the disaster of independence and
objectivity. 

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