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Companies Using Compensation Consultants Pay CEOs More with No Shareholder Benefit

October 26, 2007
Using a compensation consultant is seen by many CEOs as a good business practice to get a fair price for executive pay.

No wonder, according to a study released by The Corporate Library, which found that companies using consultants award their CEOs higher compensation and at levels that don’t relate to increased shareholder return.

In fact, those companies that disclosed the use of compensation consultants in filings with the Securities and Exchange Commission were found to have slightly less total shareholder return than those that did not disclose using such consultants. After a regression analysis, the result was a wash—shareholder returns were not found to be any better off for the use of the consultants.

Study author Alexandra Higgins admitted that the study’s results are far from proving that compensation consultants are part of the problem with rising CEO pay. However, she wrote that the findings indicate that such consultants do not increase the effectiveness of incentive plans.

“We did see some patterns,” Higgins says.

The study, which examined 2,583 company filings from February to May, found that 51 percent of the companies disclosed the name of their executive compensation consultant. Twenty-nine percent of those companies used Towers Perrin, 22 percent used Mercer and 19 percent Hewitt Associates. SEC rules now require companies to disclose which compensation consultant they use for executive pay.

Pearl Meyer, which was used by 8 percent of the reporting companies, was found to be the consultancy that led to the highest CEO base salary, at an average of almost 19 percent above median CEO salaries among peer companies. Towers Perrin, Mercer and Hewitt were the next in line for high CEO pay, coming in at roughly 17 percent, 15 percent and 15 percent above the median, respectively.

Bonuses and equity awards to executives boomed among companies using consultants. For example, CEOs of companies that used Frederic W. Cook saw an average bonus pay of 194 percent of salary. Pearl Meyer was the leader in terms of favoring equity compensation, paying on average 198 percent of company targets for the maximum number of shares. Companies and compensation consultants set such targets for equity, but often pay more than those targets.

The leading consulting firms were not consistently at the top of compensation in all areas, though. Towers Perrin and Hewitt, both in the top three for doling out the highest base salaries, were among the bottom four firms for the value of stock options granted. That is likely due to philosophical differences among the consultants, in that some may see cash as a higher incentive while others think equity awards are better for execs, Higgins says.

Compensation consultants have come under fire from unions and shareholder groups. One of the most notable examples was Hewitt Associates, which was used by Wyeth and Verizon. After Verizon's unions challenged the company's compensation levels and the work done by Hewitt, as well as ties between the boards of Verizon and Wyeth, the telecom giant dumped the firm as its consultant in 2006 and Wyeth chose another consultant in April.

Rep. Henry Waxman (D-California), the feared chair of the House Oversight Committee, earlier this year began an investigation into the leading consulting companies over alleged conflicts of interest in setting executive pay. That investigation is still ongoing, sources say.

This story was filed by Nicholas Rummell of Financial Week, a sister publication to Workforce Management.