By James Hamilton, J.D., LL.M.
A House oversight committee report found widespread and pervasive conflicts of interest among executive compensation consultants. Indeed, over 100 large public companies hired compensation consultants with substantial conflicts of interest in 2006. In many cases, the consultants advising on executive pay were simultaneously receiving millions of dollars for other services from the corporate executives whose compensation they were hired to assess. The report further found that over two-thirds of the Fortune 250 companies that hired compensation consultants with conflicts of interest did not disclose the conflicts in their SEC filings. Some companies informed shareholders that the compensation consultants were independent when in fact they were being paid to provide other services to the company.
The report was prepared by the Committee on Oversight and Government Reform, chaired by Rep. Henry Waxman. Concomitant with the release of the report, the Committee held hearings on the role of compensation consultants.
SEC rules require companies to disclose the identity of their compensation consultants and describe the nature of their assignment. The rules do not, however, require companies to disclose whether the consultant has other business relationships with the company or the fees received for providing executive pay advice and other services.
Corporate governance experts recommend that companies hire independent executive
compensation consultants that are free of conflicts of interest and can provide objective
advice regarding executive pay. One leading expert, Professor Charles Elson, testified that the best practice is for the consultant advising the compensation committee to be hired exclusively by the committee and perform no other tasks for the company or its management. Professor Elson emphasized that directors who negotiate pay must receive completely objective advice from outsiders solely responsible to the compensation committee, uncompromised by managerial relationships. This approach is similar to that taken with regard to outside company auditors under the Sarbanes-Oxley Act, he explained, and has been endorsed by numerous business and investor organizations, including the National Association of Corporate Directors.
The Committee’s investigation also uncovered evidence that companies may not be disclosing the identity of all consultants hired to provide executive compensation advice. SEC rules require companies to disclose any role of compensation consultants in determining or recommending the amount or form of executive compensation and identify such consultants. Further, according to SEC guidance, companies must disclose all consultants that played a role in determining executive pay, not just the consultant advising the board or its compensation committee.
The committee found that companies used executive compensation consultants that they did not disclose. In some cases, the companies paid hundreds of thousands of dollars to undisclosed consultants for executive compensation services. One explanation for these discrepancies may be that the compensation consultants used a different definition of executive compensation services in reporting to the Committee than the companies used in their SEC filings.
The executive compensation services reflected in the consultants’ submissions to the Committee could include a broader range of activities than those required by the SEC to be disclosed to shareholders. If a company hired a consultant only to provide survey data on executive pay, for example, this work could have been reported by the consultant to the Committee as executive compensation services, but the company may not have considered the consultant’s work to involve “determining or recommending” the amount of executive pay under the SEC disclosure rules.
Alternatively, although it appears inconsistent with the SEC guidance, a company may have disclosed in its SEC filings only the compensation consultants that provided services to the company board.