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For “compensation consultants, prostitution would be a step up,” said Charlie Munger during Berkshire Hathaway’s annual shareholder conference.Hired by corporate boards of directors, these advisors are expected to provide independent consultation on behalf of the shareholders.
But with executive pay continuing to skyrocket as many companies face a challenging economic backdrop, many continue to have doubts about the services compensation consultants actually provide.
Business Insider reached out to compensation consultants and corporate governance experts to get a more intimate understanding of what this business is really all about about. Our case study: The Walt Disney Company.
Meet Bob Iger, the Walt Disney CEO Who Will Get 8-figures through 2016
In March, shareholders approved a sweet new employment agreement for Disney CEO Bob Iger.
Iger gets a base salary of $2,500,000 through 2016. He will also enjoy a minimum fair value long-term incentive compensation award of $15.5 million and a minimum target bonus of $12 million through 2015.
Previously, Iger was paid $2 million in base salary, with a target bonus of $10 million and long-term compensation of $9 million, according to Disney’s March 7 proxy statement.
In its proxy statement, Disney’s board explains that the raise came via negotiations with Mr. Iger, who was also named chairman in the new agreement, and in consultation with the compensation committee’s independent consultant, Pay Governance LLC.
At the same time, the proxy statement also claims that the compensation committee “determines the compensation of the chief executive officer without management input,” even as it is “assisted in this determination by its independent compensation consultant.” So how exactly does the firm, Pay Governance LLC, remain independent if Mr. Iger remains a negotiating partner?
Keeping Up With The JonesesPeople refer to the problem of escalating executive salaries as the “Lake Wobegon” effect, a reference to Garrison Keilor’s fictional town where “all the children are above average.” Substitute “children” for “CEOs,” and you get the idea. In a 2006 letter to shareholders (.pdf), Warren Buffett took aim at the pay consulting industry, referring to the fictional firm of “Ratchet, Ratchet and Bingo” as advising some of the companies notorious for paying stratospheric compensation to CEOs.
Despite recent efforts to address the independence of executive compensation consultants, interviews with compensation experts reveal a central conflict remains: consultants are ultimately beholden to a compensation committee’s instructions.
And while a compensation committee ostensibly acts in the interests of shareholders, they will usually go to great lengths to keep CEOs — and instruct consultants to act accordingly.
“It’s the ‘keep up with the Joneses’ theory,” said Pamela Greene, a corporate governance expert at the firm Mintz Levin. “So it’s perpetual. If you think everyone else is getting pay raises…No one wants to be an outlier if they have a really good executive.”
Karl Okamoto, a professor of securities law and corporate finance at Drexel’s Earle Mack School of Law, was more direct: “I don’t see them frankly as being anything more than just there to paper over the decision.”
‘Sorry, not doing that.’Most compensation consultants, as well as CEOs, say a consultant’s primary function is numbers cruncher. Consultants publish annual or quarterly data on compensation trends, the more thorough of which can cost clients thousands of dollars.
“To do this well, you’ve got to know about economies of pay, the industry you’re working in, and you’ve got to know all regulatory and compliance issues,” said George Paulin, a principal at Frederic W. Cook & Co., one of the country’s longest-running pay consultancies.
The situation becomes more muddled when consultants puts on their other hat, that of adviser. In theory, a compensation committee acts in the interest of shareholders.
But according to Jesse Fried, a professor at Harvard Law School who’s written extensively on corporate pay, consultants’ advice simply reflects the desires of a comp committee.
Even if a consultant tried to present a shareholder-friendly recommendation, if it was against the committee’s wishes, it would get rejected.
“The directors present the idea to the CEO, the CEO says ‘No way,’ and the directors say ‘Sorry, not doing that,’ to the compensation consultant,” Fried said.
“Net time, the consultant won’t even try.”
Fried said he knows of a compensation consultant who was actually able to get comp committee members of a large firm excited about the possibility of adding more shareholder-friendly features to a CEO’s pay package.
What’s more, board members serving on compensation committees can lack incentive to show restraint toward CEO pay, he said.
“For a variety of social, psychological, and financial reasons, directors have little interest in negotiating at arm’s length with the CEO over pay,” he said.
Photo: Flickr / Johnny Vulkan
“The CEO is their colleague, haggling is unpleasant, and it’s not the directors’ own money. The CEO, on the other hand, cares about every dollar. The comp committee will thus typically want the consultant to come up with a package that will please the CEO. And the consultant will of course oblige.” Greene is more sanguine about the role of compensation committees, saying they act in good faith. If they’re looking to justify a CEO’s pay raise, it’s most likely for sound reasons, she said.”If you have a good CEO, you don’t want to lose him to the company across the street,” she said. “If you think he’s going to be poached, like the sports industry or any other industry, it’s coming from external pressures, not ‘He’s my friend.’ “
Yet that still leaves compensation consultants at the mercy of their employers. One former employee of a large compensation consultant, who wished to remain anonymous because he did not wish to endanger his future employment, described the ultimately supine role advisers play.
“We don’t have any actual control,” he said. “If the board wants certain things, there’s nothing we can do about it. There were lots of things I didn’t agree with. We did pretty good job pushing back, saying ‘This is what’s right.’ So we’d do our best to present our data, [but] the board [members] are the ones deciding what to pay the C-suite.”
Paulin conceded the final decision when he advises clients is out of his hands.
“Where we’re involved, we are certainly important and respected participants in the process, but the compensation committees make the ultimate decisions,” he said.
Photo: kb35 via Flickr
A Carousel Of CompsOne of the main determinants of executive pay are comp firms — what other companies of ostensibly comparable size and industry pay their CEOs.
Disney has been unusually active in swapping peer firms in and out of its comparable pay models, says Paul Hodgson, senior research associate at GMI Ratings, which evaluates companies’ proxies.
“The majority [of companies’ peers] are relatively consistent, except in the face of mergers and bankruptcies,” Hodgson said.
Prior to 2008, Disney usually had a dozen firms in its peer group, a list that included Viacom, Starbucks, Harrah’s and Carnival Cruise Lines.
After 2008, however, the list exploded to more than 30 firms, with different companies being added and removed in different years.
In 2011, for example Disney added Coca Cola and dropped SAP and Emerson. Here’s how the move was explained in Disney’s proxy statement for that year:
“By the end of the fiscal year, this list was revised to add Coca Cola (because it is deemed to be a comparably-sized business whose consumer-oriented focus was determined to be similar to that of the Company) and to delta Emerson Electric and SAP (because their revenues are significantly below the median revenue of the group and their consumer focus is indirect).”
Greene, the corporate governance expert, says some companies, at the explicit or implicit instruction of the CEO, will cherry pick which firms they recommend to consultants to use as comparables to arrive at a desired figure.
“Companies want to look like certain companies,” she said.
The former compensation consultant employee said that when it came to choosing peer firms, they could sometimes end up with five or six different comparative groups.
“Generally we could tell if the board was trying to get to certain answer,” he said.
A Highly Remunerative ServiceAccording to a recent New York Times piece by Kevin Roose on the industry, consultants can get paid hundreds of thousands of dollars for their services. The former consultant said entry-level salaries alone started around $75,000; partners of firms could make at least $500,000.
In the case of Disney, the company’s shareholders had reason to believe they weren’t getting their money’s worth from Pay Governance, according to ISS, a corporate governance advisory firm.
In a review of Disney’s proxy, ISS said its degree of concern over Iger’s pay for performance was “high.”
ISS described Disney’s one and three-year total shareholder return as “mediocre,” and that compared to ISS’ own list of Disney’s comp firms — which was limited to 14 companies including Nike, Comcast and McDonald’s — Iger’s pay was misaligned.
While the median CEO pay for these firms in 2011 was about $20.5 million, Iger received $36.7 million.
“While the company’s financials have improved under Iger’s leadership despite difficult economic conditions, a financial comparison against Disney’s selected 28 peers on a range of financial metrics, such as revenue growth, EBIT margin, and return on equity shows that Disney has generally lagged the median of this same peer group,” ISS wrote.
“At the same time Iger’s total pay has ranked at or above the 75th percentile for most years. His new agreement with increases in base salary and long-term incentives will likely solidify his pay in the upper quartile.”
For its services in advising the board on Iger’s pay, Disney’s board paid Pay Governance 1.5% of gross revenue for fiscal 2011, according to the proxy.
Photo: Pay Governance
But the committee states it has a policy not to pay a consultant more than 1% of annual gross revenues in order to preserve independence.So to the committee “conducted a further assessment of Pay Governance’s independence.” It concluded that in light of having satisfied all other independence requirements, the extra amount was warranted. The board also says the cost of using Pay Governance grew to 1.5% of gross revenues “as a result of unique circumstances that led to the Committee’s request for additional work to gain independent advice.” Pay Governance declined to comment for this article.
In an SEC filing responding to ISS’ memo, Disney said Iger’s pay was justified.
“Mr. Iger’s compensation is entirely in line with the compensation paid chief executive officers of the five other media peers [CBS, Time Warner, Comcast, Viacom and News Corp],” the company said. “With the exception of 2008, Mr. Iger’s compensation during his tenure as chief executive officer has been near to or lower than the median reported compensation of the chief executive officers of these companies, despite the fact that the Company is a larger and more complicated company than any of these peers.”
Disney did not respond to an emailed request for comment.
Congress has tried to address consultants’ conflicts in the past.
In 2007, a Congressional investigation led by Henry Waxman confirmed that conflicts of interest among compensation consultants were widespread.
As a result, the SEC ended up passing legislation requiring companies to disclose whether a consultant was providing dual services, and if so how much they were being paid.
To preempt such conflict of interest issues as well as head off further legislation, many of the major consultants spun off separate executive compensation boutiques — Hewitt, the subject of an article by Gretchen Morgenson, created Meridian; Mercer spun off Compensation Advisory Partners.
HR giant Towers Watson created Pay Governance LLC. But Greene, of Mintz Levin, says conflicts remain — and they probably can’t be addressed by Congress.
“My experience with compensation committees is that it depends on their relationship with the CEO,” she said. “If compensation committees have more familiar relations, it’s more because of friendships forged, not related to company business.”
She added: “You can add more rules, but I don’t think you’ll get anywhere.”