Dueling consultants

Posted by Marc Hodak on May 15, 2007 under Executive compensation | Comments are off for this article

Yesterday’s WSJ had an article on what boards are doing about compensation consultants. The concern among governance critics is that a major HR firm’s executive compensation practice, which might earn $200K to $300K in a year, might be influenced by that firm’s much larger, other HR practices, which could easily earn ten times that amount. Directors should be concerned, the theory goes, that the executive comp advice they get from a consultant may be colored by his colleague’s desire to sell much larger projects, and the need to keep the top guy “happy.” So, what board experiments are currently keeping the governance critics happy?

Morgan Stanley’s board, after their embarrassing compensation issues last year, hired its own compensation consultant to oversee management’s comp consultant, just to keep a check on things–an approach sometimes called dueling consultants. Citigroup, another company reacting to its critics also has a “second opinion” consultant. This may sound like a recipe for conflict among HR firms, but it’s a little more plausible than Time Warner’s solution.

Time Warner insists that their comp consultant not be associated with any other members of his firm working on other Time Warner projects. Their consulting firm, Towers Perrin, insists that there is a Chinese wall between their executive comp consultant and their other consultants. We’ve heard that one before. You’d think that people who really knew incentives wouldn’t try to sell that one, and you’d be right. But even Time Warner’s approach seems more sensible than Home Depots’.

Home Depot, a poster child for CEO profligacy, limits the overall fees their comp consultants can make from advising management to 2% of that firm’s total revenue. The theory is that if the HR firm’s overall profitability is not staked too much on one client, they’re less likely to do crazy things to keep that client. That would almost make sense if their consultant were one person named Mr. T. Perrin. But two percent of Mr. Perrin’s revenue is a lot of money to many individuals within a firm like Towers Perrin, some of whom might actually do crazy things to hold onto it.

In my experience, directors are far more intent than comp consultants on keeping the CEO happy. The comp consultants are plenty clever to get around any silly rules, if they wanted to, but there is little they can do to undermine directors who pay attention and make sound judgments based on a decent theory about what compensation is supposed to do. Unfortunately, what most directors are missing is not more rules, but a decent theory. Director Norm Augustine hinted at that limitation by saying,

In a perfect world, I would just as soon have a bright line you can’t cross. But I also realize that you can be so perfect that you’re not rational.