2. Consultant Independence
Over the past 5–10 years, committees have become more concerned about the independence of their consultants. In the past, compensation consultants were often engaged by management and would be brought in to discuss management recommendations with the compensation committee. As external scrutiny of executive compensation increased, there was a push to make sure that the consultant reported directly to the compensation committee — rather than to management — to reduce the risk that the consultant would feel obliged to support management recommendations in order to remain engaged by the company.
Throughout the 1990s and into the 2000s, most executive compensation consulting arrangements were with large, multi-service human resources consulting firms (e.g., Towers Watson, which was created by the merger of Towers Perrin and Watson Wyatt, Hewitt, and Mercer). Over time, shareholder advisory firms, certain institutional investors, and the press raised concerns about potential conflicts of interest for these firms. They posed the question, “Would the compensation consultant with annual fees of $150,000 really be willing to confront management on executive compensation if it put annual pension benefit consulting fees of $3–$5 million at risk?” The presumptive answer was that this was indeed a conflict. As a result, over the past 5–10 years, many large companies have transitioned from using multi-service consulting firms to working with boutique consulting firms that only provide executive compensation consulting advice.
Concerns about consultant independence culminated in the Dodd-Frank legislation, which requires committees to consider the following six independence factors when engaging a consultant:
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Criteria |
Assessment |
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Does the consulting firm receive any revenue from XYZ Company for services other than executive compensation consulting? |
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What is the percent of revenue estimated fees represent as a percent of the consulting firm’s annual revenue? |
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Does the consultant have any personal relationships with members of the board of directors or executive officers at XYZ Company? |
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Does the consultant have any business relationships with members of the board of directors or executive officers at XYZ Company? |
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Does the consultant directly own any shares in XYZ Company? |
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Does the consulting firm have a written policy for managing conflicts of interests? |
The committee is not required to hire an independent consultant. If the committee does determine that a conflict of interest exists for the consultant and still decides to proceed, the company must disclose how the conflict was addressed. However, to avoid the perception of a conflict of interest, it is likely that most compensation committees will avoid working with consultants who give concerning responses to any of the six questions.