In the midst of all the attention (mostly, if not entirely, negative) that executive compensation is getting these days, there is particular scrutiny of the role of compensation consultants. A recent report from the Congressional Committee on Oversight & Government Reform focused on the presence of a financial conflict of interest for compensation consultants when they provide both executive compensation advice and other services to the same company - an opinion bolstered by the Committee's finding of a correlation between the level of CEO pay and the presence of just such a purported conflict on the consultant's part.
Into the fray jumps a group of Wharton accounting professors (and others) whose research presents us with a different picture of the situation. Their study, The Role & Effect of Compensation Consultants on CEO Pay, featured in a recent Knowledge@Wharton article, found that while executives do get paid more when compensation consultants are involved, the CEOs are still held to acceptable pay-for-performance standards. "We are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary," concluded the researchers.
From the article:
To examine the question of whether consultants' conflicts of interest influenced CEO pay, the researchers divided the consulting firms into two broad groups. Those that may provide no services except for compensation consultation were categorized as having no conflict of interest. The consulting firms that may provide other services were characterized as having potential conflicts of interest. The authors use three different ways of dividing the firms into these two categories -- whether the hired consultant's market strategy is not to provide other services, whether firms disclose that the consultant does other work, and whether the firm's auditor provides non-audit services.
"We find no evidence of rent extraction -- [i.e., giving unjustified or unwarranted pay to the CEO] -- in the form of lower pay-performance sensitivity among the clients of these consultants," the researchers write. "Overall, we do not find compelling evidence that the controversy and accusations regarding the use of potentially conflicted compensation consultants are warranted."
Their conclusions differ from those of Waxman's committee, which based its findings not only on information disclosed in proxy statements of Fortune 250 companies, but also on information specifically requested from six top consulting firms. The firms were asked to provide information on what other services they provided to companies they consulted with.
"In 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interests was 67% higher than the median CEO salary of the companies that did not use conflicted consultants," the Waxman report concluded. "Over the period between 2002 and 2006, the Fortune 250 companies that hired consultants with the largest conflicts increased CEO pay over twice as fast as the companies that did not use conflicted consultants."
Carter offers two explanations for the differences between the two studies. She says the Congressional committee did not take into consideration a number of variables that her study did. "The study failed to control for economic determinants of pay and therefore its conclusions should be interpreted with caution," she and her colleagues write. For example, bigger and well-performing firms tend to pay their CEOs more. If these types of firms are also the kind of firms that hire consultants to provide other services, the Committee could have been led to their conclusion, not because the conflicts led to higher pay, but because the characteristics of these firms warranted greater pay, Carter states.
Still, she acknowledges that it's possible the House committee is right and her team is wrong. The Congressional committee had the benefit of subpoena power, Carter says, so it had a clean measure of conflicts of interest because consulting firms provided proprietary information on revenues from executive compensation consultant and other services.
While Carter said she has requested, with no success, the data used by the committee, she, Cadman and Hillegeist concede that the imprecise measures they used might have led to their conclusion. According to Cadman, "without [the Committee's] data, we have no way of knowing the true cause of the difference in conclusions."
For the record, I am not currently involved in providing executive compensation consulting to Fortune 500 size companies, nor do I provide any services beyond compensation/performance management - so I don't see myself as having a particular axe to grind here (other than, perhaps, the wish not to see my profession unnecessarily pilloried). I do, however, think that the reporting on this issue has been pretty one-sided, and so I welcome the chance to share a different perspective from as reputable a place as Wharton.