Hearing Examines Executive Pay and Compensation Consultants

Today the Committee will be considering the issue of executive compensation. Reports of astronomical payouts to corporate CEOs have led many to question the fairness and effectiveness of the system for setting executive pay. We will be exploring these questions today.

In the 1980s, the CEOs of the nation’s largest companies were paid 40 times more than the average employee. Now they make over 600 times more. At a typical company, 10% of corporate profits — a staggering sum — goes into the pockets of top executives.

These huge pay packages raise a basic question: Are corporate CEOs working for the companies who hire them or are the companies working for the CEOs?

Many academic experts, financial analysts, and investors believe that soaring CEO paychecks are a symptom of a corporate governance system that is not working. As noted, investor Warren Buffett has commented: “In judging whether Corporate America is serious about reforming itself, CEO pay remains the acid test.”

Today’s hearing examines a practice that may be fueling this dysfunctional pay system: the use of executive compensation consultants with conflicts of interest.

Executive compensation has become incredibly complex. CEOs don’t just get salaries any more. They get stock options, restricted stock units, deferred compensation, executive pension plans, lucrative severance packages, and a vast array of perks from corporate jets to tax and financial planning services and country club memberships. These compensation packages can be worth hundreds of millions of dollars.

Many companies now rely on the services of professional executive compensation consultants to evaluate these complex pay arrangements. Last year, in fact, over three-quarters of the Fortune 250 retained outside compensation consultants.
Most Americans have never heard of Towers Perrin, Mercer, and the other influential compensation consultants. But these pay advisors can have an enormous impact on executive pay. When they do their job right, they can align the interests of the CEO with the interests of the shareholder. But when they do their job wrong, the result can be vast wealth for the CEO and a plundered company for the shareholders and employees.

That’s why it’s so important that these pay consultants be independent and free of conflicts of interest. Consultants who are paid millions of dollars by a corporate CEO won’t provide objective advice to the board. They know what the CEO wants to hear and they know what will happen to their lucrative contracts if they don’t say it.

For the last seven months, the Committee has been investigating conflicts of interest among compensation consultants. Today I am releasing a report that summarizes what the majority staff has found.

The results of our investigation should concern everyone who cares about corporate governance: over 100 of the biggest companies in America are using compensation consultants with significant conflicts of interests to set CEO pay.

Last year, 113 Fortune 250 companies retained conflicted consultants. These consultants typically receive $200,000 to advise the company about executive pay — and over $2 million to provide others services, like benefit administration, to the company.

In effect, the consultants are being asked to evaluate the worth of the executives who hire them and pay them millions of dollars.

Like the auditors who signed off on Enron’s books, they have an inherent conflict of interest. For every dollar the consultants are paid to advise on CEO pay, they are being paid $11 dollars by the CEO to perform other services to the company.

What’s more, few of these conflicts are being disclosed to shareholders. We found that some companies called the consultants “independent” in their proxy statements when in fact the consultants were being paid millions of dollars to provide other services.

And when we looked closely at the conflicts, we found that the Fortune 250 companies that use consultants with the most extreme conflicts of interest paid their CEOs more — and raised their pay faster — than other companies.

Today’s hearing will give us additional insights on this issue. Our first panel includes corporate governance experts and institutional investors that have experience identifying, assessing, and addressing potential conflicts of interest. I thank them for being here.

And our second panel consists of the consultants themselves. We’ll hear their side of the story: how they handle conflicts of interest and what they do to mitigate their impact. I appreciate their cooperation in the Committee’s inquiry and their willingness to appear before the Committee today. I am disappointed, however, that two leading compensation consultants — Watson Wyatt Worldwide and Pearl Meyer & Partners — declined our invitation to testify today.

At bottom, the issue we are examining today goes to the heart of the executive compensation process: Are soaring CEO pay packages earned or are they the result of a rigged process? Today’s hearing will give us a new perspective on this important question.