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1. Compensation Consultants

Under Dodd-Frank and the listing standards for the NYSE and NASDAQ, compensation committees are empowered to hire external advisors to assist them in managing their responsibilities. The legislation requires companies to provide funding for the committee to pay an external advisor if the committee decides to use one. Annually, the committee is required to conduct a review of the candidate’s independence (if they use a consultant).

Why Use a Compensation Consultant?

It is a testament to the complexity surrounding the issue of executive compensation that the overwhelming majority of compensation committees use a consultant. On the surface, the decision on how much to pay a company’s senior executives may seem simple enough. However, there are multiple advantages to including a consultant as part of the process:

  • Third-Party Independence: If management is left alone to develop recommended compensation levels and design, their self-interest would encourage them to propose relatively high compensation levels and low performance standards. The use of a third-party advisor helps to ensure that the information used as the basis for establishing recommended pay levels and performance standards does not have a bias in favor of management. Since consultants are engaged by the committee, their incentives tend to be more closely aligned with those of the committee members.
  • Experienced Advisory: Experienced consultants have worked with hundreds of clients over their careers and can therefore advise on many situations that might be new to individual compensation committees. A strong consultant will have learned from past experiences and can share that knowledge with committee members to provide assurance when making decisions.
  • Competitive Information: Through past client exposure and firm resources, consultants can provide detailed information on competitive practices to the committee. While competitive data should not be the primary basis for committee decision-making, it is a valuable input and can provide comfort to committee members that the designs they are implementing do not deviate from common market approaches. In the words of Jill Kanin-Lovers, the consultant “needs to keep you smart.”
  • Technical Expertise: The design of executive compensation programs requires knowledge across multiple disciplines, including tax, accounting, SEC disclosure rules, and insider trading. In addition, it is critical to have an understanding of the financial drivers of business success. While compensation committee members may excel in their understanding of business strategy and financial performance, it is unlikely that they will have adequate technical knowledge to navigate the intricacies of executive compensation design on their own.
  • External Cover: The reality of the business world today is that there is no shortage of external scrutiny of corporate decision-making. The recently adopted “Say on Pay” proposals have served as the basis for shareholder lawsuits, and executive compensation has long been a popular topic for the business press. The use of a consultant allows the committee to demonstrate to external critics that they tried to “cover all bases” in developing the compensation program. In the event of a lawsuit, if the committee has used a consultant, they can point to their independent, third-party advice as an input into their decision-making.

Typical Consulting Arrangements

The nature of the arrangement and the level of workload required factor into how much a consultant will be paid. In our experience, an annual consulting engagement with a compensation committee could cost as little as $50,000 if the role of the consultant is geared towards simply reviewing and commenting on data and recommendations developed by management (and/or its consultant) with occasional meeting attendance. In other cases, the consultant reports to the committee but works with management to develop recommendations. In these cases, fees can range from $100,000–$500,000 depending on the complexity of the company’s compensation programs and decision-making processes. Similar to law firms, most consulting firms will charge clients based on the hours required to complete the work according to an hourly billing rate. Consultants will generally provide an estimate of fees for the year associated with anticipated work steps.

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