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Senior Democrat Links Consulting Conflicts to High Exec Pay

The new report, which was the centerpiece of a House committee hearing, says 113 of the Fortune 250 companies used consulting firms for pay guidance as well as other services in 2006.

December 6, 2007
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Compensation consultants whose firms engage in other types of business with the same client contribute to skyrocketing executive pay, according to a senior House Democrat.

On Wednesday, December 5, Rep. Henry Waxman, D-California and chairman of the House Oversight and Government Reform Committee, released a nine-page report written by the panel’s majority staff that outlines “pervasive” conflicts of interest and asserts that the more conflicts there are, the higher a CEO’s pay will be.

The report, which was the centerpiece of a committee hearing, says 113 of the Fortune 250 companies used consulting firms for pay guidance as well as other services in 2006. Fees for compensation work averaged $220,000, while those for other projects amounted to $2.3 million.

The survey of six leading consulting firms also showed that CEO median salaries at companies who hired them for the most work were 67 percent higher than the median pay of CEOs at companies that didn’t use “conflicted consultants.”

“For every dollar the consultants are paid to advise on CEO pay, they are being paid $11 by the CEO to perform other services to the company,” Waxman said. “They know what the CEO wants to hear and they know what will happen to their lucrative contracts if they don’t say it.”

Committee Republicans were skeptical of a link between consultants and executive pay. Rep. Tom Davis, R-Virginia and ranking member, said he doubts there is a link between compensation consultants and corporate malfeasance.

“It’s an interesting theory, one steeped in anti-corporate populism,” Davis said. “But there’s little proof it’s true.”

Consulting firm executives at the hearing defended themselves. Representatives from Towers Perrin, Hewitt and Mercer said guidelines and protocols they follow prevent tainted compensation advice. They also asserted that boards of directors, not the consultants, make the final pay decisions based on market factors.

An academician who appeared before the committee advocates independent compensation committees hiring consultants who concentrate only on compensation.

But in an interview after his testimony, Charles Elson, a University of Delaware professor, said consultants have limited influence on soaring CEO pay.

“The real issue is an overreaching CEO and a passive board,” Elson said.

Market pressure also plays a big role. “No one ever wants to pay their CEO below the 50th percentile,” he said.

Even the lowest percentile would put executives at a salary level well above those who work for them. Waxman cited statistics that show CEO pay at large companies has grown from 40 times that of an average worker in the 1980s to 400 times today.

Most Americans look suspiciously at huge executive compensation packages, according to Waxman.

“They think the system’s rigged,” he said.

Waxman produced a Towers Perrin job ad for an executive compensation consultant that stated one of the position requirements was “cross-selling consulting and other Towers Perrin services to existing and new clients.”

Donald Lowman, managing director of Towers Perrin, said the ad was for a junior-level position that would never advise a compensation committee.

“Compensation consultants don’t get involved in selling any other services for Towers Perrin,” he said.

Lowman asserted that consulting firms would hurt themselves if they promoted gross CEO overpayment.

“The reputations of our companies are not for sale,” he said. “Corporate America has never been more conscious of executive pay and the consequences of not getting it right.”

In an interview after the hearing, Lowman said discussions about executive pay are undermined by faulty assumptions about cozy relationships between consultants and CEOs.

“There’s a pretty broad misunderstanding in the public generally as well as on the committee about what constitutes good corporate governance,” he said.

Towers Perrin wasn’t the only company in Waxman’s sights. He also pressed Charlie Scott, president of human capital consulting at Mercer, about why Mercer’s parent company, Marsh and McLennan, states that it hires compensation consultants who do no other work for the firm.

Scott responded that Mercer follows a set of global business standards that ensure the integrity and transparency of compensation advice. It also advises compensation clients to hire a separate independent advisor in addition to Mercer.

“We allow them to decide if and how they want to use us and in what way,” Scott said. “Potential for conflict doesn’t mean there is conflict.”

If problems exist in setting compensation levels, the market should sort it out, not Congress, according to several Republicans on the oversight panel.

“This has to be the most far afield hearing I’ve seen in the three years I’ve been in Congress,” said Rep. Virginia Foxx, R-North Carolina. “Here we are meddling in the private sector where we have no business being.”

Rep. Mark Souder, R-Indiana, was more pointed.

“This hearing is one of the most appalling we’ve ever had,” he said. “This is just embarrassing.”

For Democrats, however, delving into enormous pay disparities is a way to address what they call middle class anxiety about difficult economic circumstances.

—Mark Schoeff Jr.

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