Like a lightning rod during a Maine thunderstorm, The Corporate Library has a way of drawing charges — from critics in whatever industry it is studying at the time. And sometimes, from outsiders as well; CFO.com, for example, raised questions a year ago about flaws in TCL’s report on stock-option backdating.
Some criticisms aimed at its October 2007 project, “The Effect of Compensation Consultants: A Study of Market Share and Compensation Policy Advice,” appear premature, however. The study, which acknowledged that comparisons among the 10 largest firms reflected only the first year of data available under broadened corporate proxy-disclosure requirements, appears to be an early building block in what could be valuable research. Expanding the study, as the Portland, Me.-based research center says it plans to do, may provide results both to ease shareholder worries about executive compensation that doesn’t reflect actual performance, and help companies select consultants best suited to corporate needs.
At its most basic, the 13-page “Effect of Compensation Consultants” report had modest goals and a very basic methodology. But it showed a wide variance in pay results in all the compensation categories studied.
Starting with the measurement of consultant market shares — from Towers Perrin and Mercer as the largest at 29 percent and 22 percent, ranging down to Clark Consulting and Compensia at 3 percent each — the study looked at CEO base pay at the consultants’ clients, rated as a percentage against a peer median salary. The study then ranked average client-firm bonuses by consultant, as a percentage of salary, and did the same for stock-option values compared to a peer level. Other tables rated target values of performance-related non-equity incentive comp and equity awards as a percentage of salary.
In some of the key measurements, Pearl Meyer’s clients averaged 18.58 percent above the peer median salary, while Radford’s clients averaged 0.18 percent below peer level, and Compensia’s rated a full 16.20 percent below the median. And in bonuses paid, Frederic W. Cook clients and Hewitt Associates clients weighed in at 194 percent and 188 percent of salary, respectively, while consultants with clients paying bonuses less than 100 percent of salary were Clark (87 percent), Compensia (83 percent), and Radford (79 percent). Others among the top 10 were Towers Perrin (170 percent), Pearl Meyer (168 percent), Mercer (167 percent), Hay Group (153 percent), and Watson Wyatt (106 percent).
To an unusual degree for a Corporate Library study, conclusions based on the numbers seemed quite neutral. “One of the things that I wanted to be very clear about is that the disclosure requirements here (from the Securities and Exchange Commission) are very new. We’re only one year into them,” TCL research associate Alexandra Higgins, the report’s author, tells CFO.com. “A lot of the reaction to the report was that the result might be very different if we covered a longer term,” she adds, although she notes that her “sense” — while unsupported by data — is that “a difference in the results would be highly unlikely.”
Ammunition for the House
Despite the humble goals of the study, however, it quickly became part of a debate about the consultants’ role in executive pay — and especially about charges of conflicts of interest among consultants that perform multiple advisory services for the same client. The report was cited numerous times, for example, during the heated debate early this month in the House Committee on Oversight and Government Reform, chaired by California Democrat Henry Waxman.
David N. Swinford, president and CEO of Pearl Meyer, tells CFO.com that the Corporate Library report overlooked in its compilations restricted stock grants and performance share plans, which are vital to the structures of many big companies. “Among the larger, more-established and more mature companies, [TCL's] analysis didn’t really look at what is often 30 percent of the pay package,” he says. Those long-term results, along with the benefits of retirement plans and perquisites, often are vital to the package created in a pay-for-performance system.
“When you look at some companies, salaries are 10 to 15 percent of the total package; that’s all they are,” Swinford says. “It’s sort of like an appetizer, and then the meal comes.” In other industries, though, salary is a much larger component of total pay. And the consultants’ plans often reflect the trends in the industries they serve.
He is also critical of the one-year time period used for total shareholder return, even though TCL argues that this is a reflection of the short amount of time over which the disclosures have been required. “One year is just too short a term, and Corporate Library uses one-year total returns a lot,” he says.
Further, Swinford questions TCL’s “peer” categories, which were created over 10 industry sectors, each subdivided into four equal market-cap ranges to provide benchmarks. “They tend to use large peer groups in basic categories,” says Swinford. “But we use related industries and similar size characteristics” in formulating peer groups, and TCL’s approach likely skewed the results in the case of Meyer and other consultants with larger clients.
As the numbers were used in the Waxman hearings, Swinford says, “they created an impression that if a consultant is involved, pay is higher. Frankly, I think that is a perception that 15 years ago had some validity. But it’s a feature of the past. Many of us now work almost exclusively for boards, and we spend a lot of time helping managements understand the pay marketplace.”
In a final blast, the Meyer CEO points out that some of TCL’s most dramatic variances among consultants are primarily a function of the type of client they serve. For example, Compensia and Radford serve younger high-tech companies, for which base salaries would be a much smaller proportion of income compared to restricted stock and long-term pay. Yet those industry differences were not explained in the study.
For its part, Compensia seems less upset with the numbers. “I always take what they put out with a grain of salt,” says Timothy J. Sparks, Conpensia’s president, of the work of the Library. “I think it probably reflects a mistaken understanding of the role that consultants really play.” Consultant-corporate relationships these days “run the gamut, with some program design, and other work dealing with boards,” he tells CFO.com. “Trying to correlate consulting firms with particular outcomes is a suspect objective.”
There was, however, one clear benefit to Compensia from the report. “We’ve only been in business for four years,” he says, “so to be considered one of the top 10 in the country is something we welcome with some pride.”
An Industry in Transition
George B. Paulin, chairman and CEO of F.W. Cook, thinks there was “a direct relationship” between the numbers released by TCL and the Waxman hearings several weeks later, even if the Library didn’t specifically take the strong anti-consultancy position that some others did in the House committee testimony.
Among his complaints about the report is the loose use of time periods for which results are reported. “If the program that paid in 2006 was put into place in 2005, and the target bonuses were set in 2006, does that make a difference?” he asks. “By inference, they’re relating the result that occurred for a certain period to the advice given during that period. That’s one thing that concerns me.” The report, he adds, “didn’t look at the whole of compensation; it looked at pieces of compensation.”
Another concern, also growing from how the Library’s numbers were used in the Waxman hearings, was that TCL didn’t make clear that certain consultants are units of insurance companies — or were at the time — and thus were in a different category from independent firms such as Paulin’s own.
“The whole industry is in transition now, the result of big companies trying to safeguard against the accusation that there’s conflict of interest here,” he says, adding that at Cook “we’ve sort of been a beneficiary of that.”
Still, TCL went out of its way not to enter the discussion about conflicts of interest, and it maintains that there was no coordination between the Waxman committee’s use of its numbers to suggest that conflicts of interest created an agenda among consultants to pump up corporate pay packages.
“That stance of being neutral was intentional,” says Corporate Library senior research associate Paul Hodgson. “This is the first year there has been widespread disclosures of consultant use, and who they are. With a single year to go on, you can’t reach many conclusions.” He adds that this initial report is seen as the first building block in a research structure that is intended to be of great use to companies and shareholders. “This is an area we’re going to revisit, definitely, as we get better data. As we move through the years of disclosure, we will certainly add in three-year and five-year total shareholder return as well.”
In preparing the report, TCL itself says it found some long-term compensation data hard to extract from the corporate disclosures. But also, “we were trying to look at the more traditional elements of compensation policy,” and restricted stock and some long-term incentives were seen as “newer” forms, Hodgson says.
With the limited data, TCL steered clear of commenting on the area of consultant independence, for example, he notes. “It’s not an issue we considered. If people were trying to draw conclusions like that from the report, it didn’t concern us at the time.” The Waxman committee “had additional data,” Hodgson says, based on surveys that showed what types of work consultants were doing with companies. The combination of such information with the Library’s data, especially when it covers longer time spans, offers a promise that future TCL reports can be of great use in compensation planning.
Says Hodgson, “What I would like to test in the future is whether the advice given initially, in terms of designing a compensation plan, provides the outcomes that were worked out for management, as well as for the shareholders.”