The Advisors' Blog

– Broc Romanek, CompensationStandards.com

On Tuesday, I attended a clawbacks seminar hosted by the Institutional Investor Educational Foundation here in DC and the idea of annual ratification of compensation consultants was floated by a few panelists. This would require public companies to place an item on their annual meeting ballot to allow shareholders to “ratify” the company’s compensation consultants, just like most do for independent auditors today. It’s an interesting idea – and I’m not surprised to see it since concerns over comp consultants often has been patterned on the concerns over auditor conflicts.

Here are some reasons why I think this idea is not a good one:

1. Leave Blame for Excessive Pay Where It Belongs – I worry that ratification of compensation consultants would place more attention on consultants than is warranted. Consultants just provide guidance when asked – it’s the board that makes the final decisions and should be accountable for badly designed pay packages. Leave the onus on the board to defend its pay package.

2. What Does Ratification Accomplish? – Just like my concerns over say-on-pay, I worry that merely placing a comp-related item on the ballot won’t drive change. In fact, I worry it may relieve pressure on the board to create change as the compensation consultants likely would routinely be ratified, just like independent auditors are today. And boards may read into the ratification that their pay design is acceptable, even if it’s not. A professor at Texas A&M did a study back in ’03 and found that the average ratification rate was 97%.

3. Compensation Consulting Industry is Limited – There is an unbelievable amount of misinformation about the pay-setting process. That is why most reform efforts sound ill-fated to me – the folks with the ideas don’t understand what is causing excessive pay, thus they don’t know how to fix it. There is so much concern over compensation consultants (conflicts, etc.) – yet most boards don’t use their services at all. [Note that companies are required to have auditors, but not consultants. However, there’s no corporate law requirement to place auditor ratification on ballots – although if a company doesn’t, ISS will recommend a vote against re-electing the board.]

In fact, there are no more than three dozen or so consultants that actually go into boardrooms to provide guidance. That’s how small the industry is! And my experience has been that the views of one consultant in a particular firm will not necessarily reflect the views of the others. There is no standardization of views within firms – so shareholders would find it quite difficult to decide how to vote with any real confidence.

4. Compensation Consultant Role May Vary – Another key difference between the role of the independent auditor and compensation consultants is that the role of the auditor is always the same, but that the role of the comp consultant often varies. Sometimes the comp consultant is heavily involved with helping a board design the pay package – but many times the consultant is limited to just providing data and general technical guidance.

Another key difference is that there is no standard code of conduct or rules about for engagements of compensation consultants; there is a full set of laws that exist for auditors.

5. Compensation Consultants Aren’t the Problem – Although the compensation consulting industry clearly perpetuates some of the problems associated with excessive pay (eg. peer group surveys), I believe that most consultants have “gotten religion” during the past five years and provide responsible guidance. Or they at least provide a responsible alternative when they respond to a client request.

This makes sense given their reputation is on the line and quite a few have already been dragged through the mud. Plus, if they lose a client, they are in high demand and can fairly easily find a new one. Given that the number of compensation consultants is fairly small – and that I regularly communicate with at least half of them – I feel like my anecodotal evidence may border on empirical.

I can’t say the same for many of the lawyers that provide guidance to compensation consultants; I hear very few speaking out for responsible practices. And of course, directors themselves need to look in the mirror.

Your Views: Ratification of Compensation Consultants

I’m just a guy in pajamas, so don’t be swayed by me. Let us know your views in this anonymous poll: