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Due dilligence on executive pay.

The simple fact is that some compensation committees do need their own consultants.

The clamor over the high levels of executive pay in the United States has reached its highest pitch yet. Critics in the media, academia, consulting, and even within some major corporations are decrying the failure of executive pay to relate closely to performance on behalf of shareholders. These critics believe that high pay levels without high performance have created a "trust gap," to quote Fortune magazine. They argue that rank-and-file employees have watched executive pay soar at the same time they have seen force reductions, fewer promotions, and smaller merit increases.

Criticism about executive pay began appearing regularly in the press as early as 15 years ago. Now, however, powerful constituencies are marshalling their resources to oppose unreasonable pay programs. Congressional committees are once again investigating excessive executive pay levels. More importantly, groups of shareholder consultants and institutional investors are aggressively opposing excessive executive pay packages.

Faced with increasing public criticism and shareholder activism, compensation committees are stepping up their efforts to exercise due diligence in approving top executive pay levels and programs. Unfortunately, these committees are handicapped in their efforts. Committee members in large companies are composed mainly of senior executives of their own companies and may serve on other boards and committees. They don't have time to do the required staff work to monitor pay.

Moreover, deciphering the labyrinth of complex incentive arrangements that compensation consultants and in-house attorneys devise requires a specialized expertise that takes even the best and most conscientious committee member years to acquire. If management hires consultants with this expertise, the consultants are dependent upon management for their livelihoods. As one compensation committee member told me recently" Our CEO's compensation package is a hodgepodge of indecipherable gimmicks constructed by a steady parade of different consultants." The consultants are changed when management doesn't get the answers it wants. Other committee members have told me that some consultants will agree to almost anything to maintain their lucrative relationship with the company.

The solution is obvious: Where any question exists about the appropriateness of pay, compensation committees should retain their own, highly qualified executive compensation consultants. Without objective advice, committees will find it very difficult to get appropriate compensation and performance data.

Top management often is leery of a committee having its own consultant, because they fear an adversarial relationship will develop with the committee and that dueling consultants will run up high fees. One school of thought argues that management needs its own consultant/advocate, because the committee's consultant will advocate the committee's position. This argument doesn't hold water. The committee has no bias or point of view to advocate. Its only desire should be - and almost always is - to make informed, objective pay decisions that will motivate and retain executives with pay levels that reasonably reflect company performance.

The simple fact is that some compensation committees need their own consultants, and there is no legitimate reason for withholding this assistance. The following guidelines can ensure that the committee gets the consulting help it needs while avoiding antagonism between the committee and its consultant, and management.



1. The compensation committee selects the consultant, who reports directly to the committee. Management can recommend candidates and express points of view, but it cannot select or discharge the consultant for senior-most executive pay programs - those affecting the top five or 10 executives, or the corporate officer group. Management may use its own consultant for all other executive and management compensation decisions. Once the committee ensures the appropriateness of pay and program design at the senior-most level, the rest of the executive pay program will fall in line.

2. The consultant reports all findings directly to the compensation committee, first. However, the consultant should meet, interview, and work closely with the human resources and other executives in reviewing pay programs and actual pay levels. The consultant should be permitted to review findings and check facts with management before going to the committee.

3. Management is barred from hiring any other consultant to analyze senior-most executive pay. If management hires its own consultant, a costly "duel" of consultants could ensue. Management is free to express any concerns about the consultant to the chairman of the compensation committee.

4. The consultant presents findings and recommendations to management in detail, after presentation to the compensation committee. This management review helps gain management's acceptance of the findings and recommendations before implementing them This also gives management an opportunity to independently approach the compensation committee if it disagrees with major aspects of the findings. My personal experience is that reasonable people who are not motivated by greed usually will not disagree with objective findings that are properly presented by a qualified consultant.

5. Only the compensation committee has the power to change consultants.The committee, of course, would take counsel from management on this matter.

Consultant's Responsibility

1. Remain objective and base findings and recommendation on the facts. The consultant must exercise extreme diligence in analyzing pay levels and programs within the company and among comparable companies. This unvarnished information should then be presented to both the committee and management.

2. Develop solutions to problems that are sufficiently acceptable to management to avoid demotivation or resignation while ensuring that pay is in line with performance for shareholders.

3. Be open to management's ideas, comments, and thoughts. However, the consultant cannot be influenced by points of view that do not agree with the facts or the best interest of shareholders.

4. Remember that the company, as an entity, and its shareholders are the ultimate clients. Thus, neither the committee nor management points of view should persuade a consultant to make a recommendation that is not in the best interest of the company.

Some compensation committees need their own consultants, and there is no good, valid reason why they should not have them. Most consultants employed be management have a dreadful record. These consultant or law firms often recommend that clients position their top executive pay levels at the 75th percentile of comparable companies, make mega-grants of the latest fashionable stock or other long-term incentive vehicle, include golden parachutes with excessive payments, and devise plans like "stock depreciation rights" that allow executives to recapture reductions in stock options gains if the stock price declines after an earlier run up.

In light of this abysmal record, it's time for a change.

Jude Rich is Chairman of Sibson & Co., a leading compensation and human resources consulting firm.
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Title Annotation:Chairman's Agenda: Governing for Shareholder Prosperity
Author:Rich, Jude
Publication:Directors & Boards
Date:Mar 22, 1992
Previous Article:Executive pay and the Board: should a compensation committee have its own consultant? No.
Next Article:A better approach to director pay.

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