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Declaring Independence

August 19, 2008
Related Topics: Compensation Design and Communication, Featured Article, Benefits
The crackdown on compensation consultants with conflicts of interest has yielded some startling results in a relatively short period of time.

Dozens of the largest companies are now opting to hire independent firms that specialize exclusively in executive compensation, rather than using large firms that—in addition to dispensing advice on executive pay—can also provide other, more lucrative consulting services, such as human resources and benefits administration.

At the same time, many other corporations are simply moving to disclose lengthy details about their relationships with their existing compensation consultants in order to quell any concerns about possible conflicts of interest that could be present if a firm provides a company with multiple types of consulting services.

In just the past year, large corporations have tapped independent compensation consultants at a considerable clip: Among Fortune 1,000 companies, 39 percent of compensation committees now rely on independent consultants for advice on executive pay, compared with 35 percent a year ago, according to an analysis of proxy filings that compensation research firm Equilar conducted at the request of Financial Week (a sister publication of Workforce Management). The remaining compensation consulting arrangements are with "full-service" firms.

These changes are taking place at a time when lawmakers have been highlighting the potential for conflicts to arise if a compensation consultant’s firm performs other work for the same client.

Led by Rep. Henry Waxman, D-California, the Committee on Oversight and Government Reform released a damning report at the end of 2007, revealing that 113 of Fortune 250 companies retained "conflicted consultants"—consultants that received, say, $200,000 to provide advice on executive pay, and yet more than $2 million to provide consulting services in other areas. "In effect, the consultants are being asked to evaluate the worth of the executives who hire them and pay them millions of dollars," Waxman declared at a hearing in December.

As a result, many companies are doing whatever it takes to avoid even the appearance of such a conflict. Corporations such as Safeway and Verizon, for instance, have changed their compensation consultants to independent firms during 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," Hodgson says. "It’s an easy solution to something that could be a potentially sticky problem."

At Safeway, the company disclosed in its proxy filing earlier this year that it hired New York-based Frederic W. Cook & Co. as the consultant to its compensation committee, replacing Towers Perrin, which continues to provide benefits consulting and compensation services to Safeway’s management team.

"It’s an emerging trend to use an independent advisor in this role," says 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, executives at independent compensation consulting firms like Frederic Cook, Pearl Meyer & Partners, Steven Hall & Partners and James F. Reda & Associates note that there has been, and will continue to be, greater demand for their services.

"Scores of large companies are putting this business out for bid right now," says David Swinford, president and CEO of New York-based Pearl Meyer, which has been hired by Verizon to replace Hewitt Associates as the company’s compensation consultant. "These companies just don’t want another thing in their proxies that they need to justify."

George Paulin, CEO of Frederic Cook, affirmed that there recently has been an increase in the number of requests for proposals issued by large companies for compensation consultants, as more companies are placing a premium on independence. But he added that not all companies are reacting to the conflict crackdown by changing consultants.

"There will be some reshuffling, but a lot of companies will also opt to disclose more information about their arrangements with compensation consultants," says Paulin, whose firm advises about 50 companies in the Fortune 250.

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

Pfizer also volunteered to disclose the fees paid to Frederic Cook for these services. In 2007, the pharmaceutical company paid Cook $150,901 for consulting with its board on 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. While only a small portion of companies actually offer this level of disclosure—about 3 percent 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 Equilar’s analysis. (The average fee for these services was $161,691 last year, a 33 percent increase from the average fee of $121,183 one year prior.)

Such disclosures appear to be even more detailed if a 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 characterized 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’s compensation consulting services: $250,368 in 2007 and $263,885 in 2006.

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 about $2 million in aggregate fees in each of the past two years. None of these fees, however, affect the compensation advice Towers Perrin provides to Time Warner, the company states in the proxy, adding that the team of compensation consultants do not work on any other consulting assignments for the company, and their own pay has nothing to do with any of these other arrangements.

"Companies aren’t required to disclose this much information," noted the Corporate Library’s Hodgson, adding that many companies are adopting formal policies on the services that compensation consultants can and cannot provide. ""They’re going above and beyond the minimum, that’s without question."

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