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Executive pay and the Board: should a compensation committee have its own consultant? No.

Should a compensation committee have its own consultant? No.

Should compensation committees have their own consultants? This question is increasingly being asked in the press, in boardrooms, and among institutional investors. It is being asked because there is a perceptions that executive pay is "out of control," that pay for CEOs and other senior executives is not related to performance, that ratios of executive pay to average employee pay are too high, and that executive pay is hurting employee morale and productivity, thereby reducing performance and global competitiveness.

There is also a perception that compensation consultants who develop executive pay programs for companies are beholden to the management, which hires them. The feeling is that if compensation committees had their own consultants or staff support, they would be in a better position to critically evaluate management's recommendations and make decisions in the shareowner's interests.

The short answer to the question of whether compensation committees should have their own consultants is "no." A "yes" answer would place the consultant in an advocacy position for the committee in opposition to management. Consultants, as contrasted with attorneys, should not be advocates of one party vs. another but, rather, should provide independent, objective advice and develop recommendations for the good of the corporation as a whole.

There may be special situations in which the committee may wish to employ its own consultant in a one-shot capacity (see sidebar). In more normal situations, however, it would be wasteful and unnecessary for both management and the compensation committee to employ their own experts in opposition to one another. Rather, if the use of a consultant is called for, it should be sufficient to employ one firm with the reputation for independence and integrity and instruct the consultant to work with management and the committee, but for the company, in completing the engagement.

Executive pay presents a potential for conflict of interests between management, which wants to be paid well for its services, and the board, which is responsible by law for hiring and compensating management on behalf of shareholders. When compensation consultants are employed by management, they risk being perceived as being on management's side in this conflict of interest and, hence, not truly objective. This leads to pressure for the compensation committee of the board, which is charged with recommending management pay programs and levels to the board, to have its own consultant to even the balance of power between management and the board over executive pay matters.

Related to the distrust of compensation consultants, who are seen as working for management, is the feeling that compensation consultants, with their extensive data bases of competitive comparisons, are responsible for the continually ratcheting upward of executive pay levels, disconnected from the underlying marketplace for executive talent, economic realities, and long-term good of the company.

And compensation consultants can find themselves in potential conflict situations if they view the client as the management that hired them. Consultants, by nature, want to be helpful. They tend to identify with the client and want to develop solutions that advance the client's interest. If they perceive the client as management, they are not likely to develop recommendations that will not meet favor with the client.

But the way to address these potential conflict situations is not for the compensation committee to hire its own consultant. This only reinforces the view that a compensation consultant who works for the management is beholden to the management and is an advocate of even higher pay levels and more attractive management compensation programs. Instead of addressing and removing the conflict, this approach accepts the conflict as inevitable and solves it by providing each side with its own consultant who represents his client's position.

While potentially doubling the revenues that might be forthcoming from executive compensation consulting practices, it is likely to lead to duplication of effort and an escalation of the contention and conflict surrounding executive pay at the board level. The reason it that, if the opposing sides in developing executive compensation programs and levels each have their own expert advisers with all the attendant egos involved, the stage is set for a win-lose confrontation rather than a mutually agreeable resolution of issues going forward.

Defining the Client

Instead of the board or its compensation committee hiring it own consultant, the solution is to make sure that the company's consultant does not define the client as the management, which hires and pays the consultant, but rather the corporation itself, for whom the management is an agent. The best consultants are those who intuitively know that the clients is the economic entity which is the corporation and that their responsibility is to help that entity develop compensation programs and processes that improve it long-term viability and competitiveness. They address conflict of interest situations, which naturally arise in this process, through integrity, strength of character, and knowledge that if in the long run they are seen as tilting their recommendations in favor of management, they will lose their reputation for independence, objectivity, and probity, and hurt their ability to get their recommendations implemented.

Unlike lawyers, who by their code of ethics serve as "advocates" for their clients, consultants should not be advocates of one party vs. another. A consultant should analyze a situation using quantitative tools and a qualitative judgment and arrive at conclusions and recommendations that are in the long-term best interest of the company regardless of who is seen as being the client or paying the bill.

It is obvious that a good compensation consultant believes in management compensation. He or she believes that management is a valued resource,that the management function is an important calling, that good management makes a difference in the long run between a successful corporation and one that fails, and that good managers should be well compensated for the added value that they create. He or she also believes that the subject of management compensation is an interesting, challenging, and dynamic field of activity and that the way in which a company chooses to pay its key employees makes a difference in the company's success or failure.

But this does not mean that more compensation is better. The definition of a good compensation program is one that is good for both the company and management, not just management. And the definition of a good compensation consultant is one who correctly analyzes a situation and develops and presents proper recommendations despite pressure to change them to fit management's self interest.

The Best Solution

In summary, while there may be special situations in which the committee needs its own expert advisers beholden only to it, the answer to the broader question of whether the committee should have its own consultant on and on-going basis to review management's proposals is generally "no." This would change the consultant's role from one of independence and objectivity to one of advocacy and could lead to greater conflict and contention rather than less. The best solution is for there to be one consultant, not two. This consultant should define the client as the total entity, which is the corporation, rather than just management, which is its agent. Through this relationship, the consultant works with management and the committee, but for the company, in developing proposals and recommendations that improve the company's ability to attract, retain, and motivate its key personnel.

Frederic W. Cook is a number of Frederic W. Cook & Co Inc. compensation consultant with offices in New York, Chicago, and Los Angeles.
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Title Annotation:Chairman's Agenda: Governing for Shareholder Prosperity; includes related article
Author:Cook, Frederic W.
Publication:Directors & Boards
Date:Mar 22, 1992
Previous Article:The curse of the quarterly report.
Next Article:Due dilligence on executive pay.

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