In Saturday’s New York Times, Gretchen Morgenson reported that House Committee on Oversight and Reform had issued a subpoena to Towers Perrin, an executive compensation consulting firm, because it had failed to comply with an information request regarding potential conflicts of interest in its pay consulting business.
Now because this was a news story, rather than her weekly column, Morgenson had to hold her tongue, so I will fulminate on her behalf.
Anyone with an operating brain cell knows that the comp consultants have had a central role in burgeoning CEO pay. It’s really simple. You create certain fictions about CEO compensation, like they have to be paid “competitively.” This is an odd notion, given that corporations aren’t baseball teams, swapping staff at regular intervals. The market for CEO comp should be pretty inefficient, given that CEOs don’t trade often and aren’t fungible (Steve Jobs may be brilliant, but how many companies could he run? You wouldn’t put him at the helm of Ford or Chevron or Pfizer, to name just a few). And you have some examples of CEOs taking well below what they could extract. For instance, Jeff Immeldt of GE paid himself only $3.2 million last year because he believes a large pay gap between him and the rest of his executive team is demotivating.
But by making pay more transparent, the comp consultants have created the illusion of liquidity in the CEO market. If we pay our CEO too little, someone might bid him away! Yikes!
Now here is the inspired bit. By virtue of creating the fear of having an underpaid CEO, many boards set targets for where their CEO should be paid in their comparable universe (that universe is created by the Delphic comp consultant). Many board have set as a target that their CEO should be paid in the upper half of the comparable universe (many set a specific target, say 50th, 60th, 75th percentile). These targets are irrespective of performance. Performance incentives go on top of that!
Now, since no board wants to believe that it has a substandard CEO (in Lake Woebegone, all children are above average), most boards set a formal or informal target of having their CEO paid in the top half. This of course is a statistical impossibility, so companies raise their CEO’s pay to keep him in the top group, which raises the averages, which forces companies whose CEOs whose pay has slipped on a relative basis to raise pay, forcing the average up again. It’s like a greyhound race. No one is ever gonna catch that rabbit.
Now why would Towers Perrin need to be bludgeoned to cooperate while other comp consultants have responded to the House document request? My bet is their records have someone commenting knowingly on how this scam works. If you can maintain the pretense that you are an honest professional and the bad outcomes are an unfortunate side effect of you innocently trying to do your job, you pass go. But if you demonstrate awareness that there is a scam afoot, and knowingly perpetuate it, you go to jail, or at least get called bad names in public.
From the New York Times:
Towers Perrin, one of the nation’s largest executive pay consulting firms, was subpoenaed yesterday by a House committee after it failed to comply with a request for information about potential conflicts in its compensation consulting business.
Representative Henry A. Waxman, the California Democrat who is chairman of the Committee on Oversight and Government Reform, is examining the potential for conflicts of interest among pay advisers who provide other lucrative services to their corporate clients.
In May, he asked the largest firms in the industry for details on their client relationships and the revenues those ties have generated in the last five years.
The firms that received the requests included Hewitt Associates; Watson Wyatt Worldwide; Mercer Consulting, a unit of Marsh & McLennan; and Towers Perrin. The consultants were given a deadline of May 29. As of yesterday, Towers had not provided the requested material.
In a letter sent yesterday to Mark V. Mactas, chief executive of Towers, Mr. Waxman wrote, “Although other firms have made significant efforts to provide complete responses to the committee’s inquiry, Towers Perrin has provided virtually none of the responsive information.
“I regret that we reached this impasse,” Mr. Waxman continued, “and that the committee had to resort to compulsory process to obtain information on whether Towers Perrin’s advice to corporate boards on executive compensation is tainted by conflicts of interest.”
A spokesman for Towers, Joseph P. Conway, confirmed yesterday that the firm had received the subpoena.
“It has always been Towers Perrin’s intent,” Mr. Conway said, “to cooperate with the committee consistent with our commitment to our clients to maintain the confidentiality of their information.
“Towers Perrin is reviewing the subpoena and is in the process of alerting its clients,” Mr. Conway said. “Towers Perrin will respond to the subpoena consistent with our legal obligations.”…..
As consulting firms have grown more powerful in the pay arena recently, the potential for conflicts has risen. Consultants typically earn far more from actuarial and benefits outsourcing businesses than they do giving pay advice; as a result, critic say, companies hiring the same firm to do both may not be receiving unbiased advice on executive compensation.
The Securities and Exchange Commission does not require corporations to disclose whether the pay consultants they employ also receive revenues from contracts in their other operations.
Congressional investigators are not the only ones interested in receiving more details about possible conflicts among consultants. Investors have begun asking the companies whose shares they own for more disclosure about these ties.
For example, shareholders of Verizon Communications voted at the annual meeting last month on a proposal that would have required it to disclose professional relationships with its current or previous compensation consultants that might taint their independence. The proposal gained support from 47 percent of the shares voted.
When he requested information last month, Mr. Waxman said that “almost everyone agrees the extravagant increases in executive compensation make no sense. The question I’m looking at is whether potential conflicts of interest among compensation consultants and their corporate clients might play a role in some of the irrational compensation decisions.”
You can see from the discussion above that this isn’t hard to understand. Do you think a comp consultant is going to justify a lucrative client relationship by recommending an less than generous pay package for the CEO?
And this problem is easy to fix if anyone had the guts. Require CEO and other top executive pay consultants to be engaged by the board of directors (right now, they are typically hired by the HR department, which is even more untenable, in terms of achieving objective outcomes) and bar firms that do top level comp consulting from providing other services to the same company. That would almost certainly lead to the comp consulting arms being spun off from most of these firms. And with the players now smaller and independent, a market might actually develop for more honest advice (it happened in the post-Enron era in M&A, where boutiques suddenly had the ear of the board because they were considered to be objective by virtue of not peddling fundraising services).
