No Collusion With Pay Consultants: Wharton Study

Last Updated Apr 18, 2008 1:25 PM EDT

Boards of directors can understandably be blind-sided by executive compensation issues. The media is filled with tales of hubris and excess while regulators require more details and explanations of how pay packages are drawn up and what CEOs must do to earn them.

Pay consultants have a thriving industry advising boards, especially compensation committees, on what's right, what's the market and what needs to be required and reported. Therein lies the rub. Do the consultants always work at an arms length? Do they have deep-rooted financial interests in keeping the overall pay of executives high while protecting executives from having to measure up to expectations?

A new study by the Wharton School concludes that there's no solid evidence of consultant collusion. The finding came after a review of 880 companies. Of them, 86 percent used compensation consultants.

The report, authored by Wharton professor Mary Ellen Carter, along with Brian Cadman of Northwestern's Kellogg School and Stephen Hillegeist of INSEAD, found that "we are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary."

The study showed that 70 percent of their sample used just five large consulting firms, including Towers Perrin, Mercer Human Resources Consulting, Hewitt Associates, Frederick W. Cook and Watson Wyatt. Other than them, Pearl Meyer & Partners was used the most often.

In general, the study found that using consultants has advantages since the experts are familiar with tax and accounting issues and are familiar with what industry competitors are doing and paying.

Critics contend that there is an unholy alliance involved. Consultants push up CEO pay and wink when CEO fail to meet stated goals. Meanwhile, the consultants solicit more work from the firms they advise and can be paid up to $10 million per firm.

The Wharton researchers could find no compelling evidence that CEOs benefit from "rent extraction" (receiving unjustified or unwarranted pay) or that compensation consultants are conflicted. Contrary findings were uncovered by a study by the House Committee on Oversight and Government Reform chaired by U.S. Rep. Henry A. Waxman. That study, completed last year, found that firms with the highest conflicts of interest with consultants also tended to have the highest compensation packages. The Waxman study, however, surveyed fewer firms, only those on the Fortune 250 list while Wharton used firms on the S&P 1500.

My take: Pick your study and make your guess. It stands to reason that there can be unseemly links between powerful and influential consultants, big pay packages and boards. The only thing that really matters in the end is just how strong and independent-minded the directors are. You are only going to get such desirable boards if you open up proxies to greater democracy and transparency and forbid management to hand pick all of the directors.