Increased concern about conflicts of interest among
compensation consultants is spurring a cottage industry of smaller firms
that primarily work for boards of directors and decline management
assignments at those corporate clients.
Activist shareholders have long complained that large
consulting firms often simultaneously advise directors about executives'
compensation and provide benefits consulting or other human-resources
advice to management. Activists say these consultants have an incentive
to please managers, who control those more lucrative contracts.
The issue gained new prominence last week when the
House Government Oversight Committee concluded that nearly half of the
250 largest public companies get executive-pay advice from consultants
who also provide other services to the company. A committee report found
that median CEO pay was 67% higher at companies with the largest
conflicts than at those whose consultants had no conflicts. The
committee is led by Rep. Henry Waxman (D., Calif.).
The report will persuade more boards to hire
consultants that do no other work for the company, predicts John F.
Olson, a senior partner at Gibson, Dunn & Crutcher in Washington.
"Congressman Waxman has given the executive-compensation business a very
nice holiday gift."
The beneficiaries will likely include about 20 small
and midsize independent consulting firms that shun management
assignments at clients when they are retained by board members. Most are
relatively new firms; half didn't exist five years ago. Often run by
refugees from bigger rivals, these firms will account for about 20% of
the $750 million spent on executive-compensation advice in the U.S. this
year, estimates James F. Reda, founder of one such firm. He thinks their
market share could double within five years.
Mr. Reda worked for three major pay consultancies
before launching his New York business in 2003. Revenue has grown 60%
every year, and the 2008 rate "could be higher," he says. James F. Reda
& Associates employs 11 people.
Compensia Inc., a San Jose, Calif., firm specializing
in the high-tech industry, counseled 158 board pay panels this year --
up from 29 in 2004, its first full year, says President Timothy J.
Sparks.
Exequity, of Libertyville, Ill., needs more pay
consultants because "we can't keep up with the pace we have," says Ross
Zimmerman, a co-founder of the 10-person firm. He previously spent 17
years at Hewitt Associates, a big human-resources consultancy.
The largest independent firm is Frederic W. Cook & Co.,
which advises board compensation committees at 54 of the 250 largest
U.S. corporations. Founded in 1973, the New York firm has long avoided
working simultaneously for boards and management. With increased
concerns about potential conflicts, "this approach has now become a
definite plus for us," says Chief Executive George Paulin.
Before the committee's report was issued, the
Securities and Exchange Commission began requiring boards this year to
reveal their compensation consultant in proxy statements. While the SEC
doesn't require disclosure of the consultant's other work for the
company, it recently asked several concerns for fuller descriptions of
pay advisers' efforts.
Worries about perceived conflicts have prompted some
boards to switch consultants. Johnson & Johnson is cited in the
committee report for paying consultant Towers Perrin more than $11
million last year for other services, far more than the approximately
$160,000 its compensation committee paid a different arm of Towers
Perrin for executive-compensation advice. J&J this year chose a
different compensation consultant, which does no other work for the
health-care giant.
The large consulting firms defend their work. Donald
Lowman, a Towers Perrin managing director, told lawmakers at a hearing
last week that his employer's integrity was "not for sale." Towers
Perrin has adopted internal practices to help clients deal with
perceived conflicts of interest.
In 2002, the board of Methode Electronics Inc. replaced
a consultancy that also served management with Donald Delves, an
independent consultant who works only for the board.
Mr. Delves, president of Delves Group, "is a very
straight shooter," says Warren Batts, a compensation-committee member at
the Chicago maker of electronic components. Based on an informal audit
by another pay consultant, he says, Methode directors recently concluded
that their company's executive-compensation plans "were in the range of
what the competition was doing -- and in the range for our performance."
Mr. Delves, who worked at Towers Perrin for 10 years,
says his Chicago firm flourished after its 2001 debut before leveling
off for several years. But in the past year, he adds, "there has been
another wave."
Theory & Practice is a weekly look at people and
ideas influencing managers. Send comments to
theorypractice@wsj.com1. For an archive of past columns,
visit
CareerJournal.com/Columnists2.
Write to Joann S. Lublin at
joann.lublin@wsj.com3
