THEORY & PRACTICE   |   JANUARY 11, 2010

More Boards Opting for Independent Pay Advisers
Concerns Grow That Multiservice Consulting Firms May Have Conflicts of Interest for a Client's Executive Compensation

By JOANN S. LUBLIN

More corporate boards are hiring smaller executive-pay consultancies amid growing concern over possible conflicts of interest at big pay consultants.

Directors at companies such as General Mills Inc. and Visa Inc. recently retained smaller pay advisers after dropping large consulting firms that provide other human-resources advice to management. More boards will likely follow, spurred by a new proxy-disclosure rule, proposed U.S. legislation and the merger of two large HR consultancies.

Activist investors contend big, multiservice consultants have an incentive to recommend that directors award rich pay packages to top executives, who control more lucrative contracts for other HR consulting gigs. Smaller executive-pay firms typically won't work simultaneously for boards and management, avoiding potential conflicts.

Starting Feb. 28, a new Securities and Exchange Commission rule mandates that shareholder proxies reveal whether boards' pay advisers do other work for the business and what fees they receive—once management services exceed $120,000 a year.

Last month, the House of Representatives cleared a bill requiring the SEC to create independence standards for board compensation consultants. And on Jan. 1, HR consulting giant Towers Perrin combined with rival Watson Wyatt Worldwide to form Towers Watson in New York. The firms held about 27% of board compensation committee gigs at Fortune 1000 concerns in the year ending Feb. 28, 2009, according to researchers Equilar Inc.

These developments probably will boost the fortunes of roughly 30 small and midsize independent consulting firms that shun management work when directors retain them. Many are relatively new and led by veteran refugees from larger firms. The latest is a New York boutique launched Jan. 4 by Ira Kay, who previously ran the U.S. executive-compensation practice for Watson Wyatt.

Mr. Kay says he opened his own shop because the proposed SEC rule, federal bill and merger accord had cost him three of his 20 board assignments at companies where Watson Wyatt or Towers Perrin provide pricier management services.

Smaller consultancies accounted for about 25% of the $750 million spent on U.S. executive-compensation advice last year, and that market share could reach 40% by 2011, predicts James F. Reda, who founded his eponymous pay consultancy in 2003. His firm's revenue has grown about 30% annually for the past five years, he says.

Farient Advisors LLC has expanded rapidly, too. The Los Angeles firm served 25 board compensation committees during 2009—up from eight in 2007, its inaugural year, says founder Robin A. Ferracone. She expects to land 10 or 15 more this year. Ms. Ferracone formerly led the human-capital business for Mercer, a major HR consultancy owned by Marsh & McLennan Cos.

Peter Chingos, another Mercer alumnus, and five fellow compensation consultants left last September to create Compensation Advisory Partners LLC. So far, every board pay panel that the New York start-up bid to advise insisted that "your organization cannot do any other work for our company," he recalls. Three years ago, he says, "maybe 20% of the proposals would have had that requirement in there."

The independent sector has long been dominated by Frederic W. Cook & Co., which counsels boards at 71 of the 250 biggest U.S. businesses. That compares with 54 two years ago.

Among Cook & Co.'s newest board clients is General Mills. Directors replaced Watson Wyatt last May after considering the move since 2008, says Michael Davis, senior vice president of HR for the packaged-foods maker. The pay panel preferred a consultancy "with no other financial ties to the company," he notes. The switch let General Mills continue using Watson Wyatt for broad-based benefits and compensation consulting, the manufacturer stated in its August proxy.

"Benefit fees were two to three times the executive-compensation fees, depending on the year," Mr. Davis says.

In changing to Cook & Co. from Towers Perrin starting last fall, Visa's board compensation committee "recognized the value of engaging an independent consultant," a company spokeswoman says, adding that Towers Watson will still provide services to management that don't involve executive pay.

Towers Watson officials declined to discuss individual clients. But some boards "for the sake of optics felt they needed an independent consultant," says Paula Todd, a leader of its executive-compensation practice. Despite recent defections, "our market share has stayed pretty much the same," adds Gary Locke, another practice leader.

In the future, "a lot of firms will hire multiservice firms like Towers Watson to work with management," Ms. Todd suggests.

Rival Hewitt Associates Inc. anticipates a similar scenario as more boards decide "to avoid additional public and political scrutiny around the perceived independence of their advisers," says Russell P. Fradin, CEO of the Lincolnshire, Ill., concern.

Write to Joann S. Lublin at joann.lublin@wsj.com