[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]




 
          EXECUTIVE PAY: THE ROLE OF COMPENSATION CONSULTANTS

=======================================================================

                                HEARING

                               before the

                         COMMITTEE ON OVERSIGHT
                         AND GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            DECEMBER 5, 2007

                               __________

                           Serial No. 110-113

                               __________

Printed for the use of the Committee on Oversight and Government Reform


  Available via the World Wide Web: http://www.gpoaccess.gov/congress/
                               index.html
                      http://www.house.gov/reform



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              COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

                 HENRY A. WAXMAN, California, Chairman
TOM LANTOS, California               TOM DAVIS, Virginia
EDOLPHUS TOWNS, New York             DAN BURTON, Indiana
PAUL E. KANJORSKI, Pennsylvania      CHRISTOPHER SHAYS, Connecticut
CAROLYN B. MALONEY, New York         JOHN M. McHUGH, New York
ELIJAH E. CUMMINGS, Maryland         JOHN L. MICA, Florida
DENNIS J. KUCINICH, Ohio             MARK E. SOUDER, Indiana
DANNY K. DAVIS, Illinois             TODD RUSSELL PLATTS, Pennsylvania
JOHN F. TIERNEY, Massachusetts       CHRIS CANNON, Utah
WM. LACY CLAY, Missouri              JOHN J. DUNCAN, Jr., Tennessee
DIANE E. WATSON, California          MICHAEL R. TURNER, Ohio
STEPHEN F. LYNCH, Massachusetts      DARRELL E. ISSA, California
BRIAN HIGGINS, New York              KENNY MARCHANT, Texas
JOHN A. YARMUTH, Kentucky            LYNN A. WESTMORELAND, Georgia
BRUCE L. BRALEY, Iowa                PATRICK T. McHENRY, North Carolina
ELEANOR HOLMES NORTON, District of   VIRGINIA FOXX, North Carolina
    Columbia                         BRIAN P. BILBRAY, California
BETTY McCOLLUM, Minnesota            BILL SALI, Idaho
JIM COOPER, Tennessee                JIM JORDAN, Ohio
CHRIS VAN HOLLEN, Maryland
PAUL W. HODES, New Hampshire
CHRISTOPHER S. MURPHY, Connecticut
JOHN P. SARBANES, Maryland
PETER WELCH, Vermont

                     Phil Schiliro, Chief of Staff
                      Phil Barnett, Staff Director
                       Earley Green, Chief Clerk
                  David Marin, Minority Staff Director


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on December 5, 2007.................................     1
Statement of:
    Elson, Charles, John L. Weinberg Center for Corporate 
      Governance, University of Delaware; Meredith Miller, 
      assistant treasurer for policy, Connecticut State 
      Treasurer's Office; Daniel Pedrotty, director, Office of 
      Investment, AFO-CIO; and Houman Shadab, senior research 
      fellow, Mercatus Center, George Mason University...........    27
        Elson, Charles...........................................    27
        Miller, Meredith.........................................    34
        Pedrotty, Daniel.........................................    55
        Shadab, Houman...........................................    44
    Lowman, Donald, managing director, Towers Perrin; Charlie 
      Scott, president of Human Capital Consulting, Mercer; 
      Michael Powers, global practice leader for executive 
      compensation and corporate governance, Hewitt Associates; 
      George Paulin, chairman and CEO, Frederick W. Cook & Co.; 
      and James Reda, managing director, James F. Reda & 
      Associates.................................................    86
        Lowman, Donald...........................................    86
        Paulin, George...........................................   124
        Powers, Michael..........................................   111
        Reda, James..............................................   128
        Scott, Charlie...........................................   103
Letters, statements, etc., submitted for the record by:
    Davis, Hon. Tom, a Representative in Congress from the State 
      of Virginia:
        Minority response........................................    17
        Prepared statement of....................................    25
    Elson, Charles, John L. Weinberg Center for Corporate 
      Governance, University of Delaware, prepared statement of..    30
    Lowman, Donald, managing director, Towers Perrin, prepared 
      statement of...............................................    89
    Miller, Meredith, assistant treasurer for policy, Connecticut 
      State Treasurer's Office, prepared statement of............    36
    Paulin, George, chairman and CEO, Frederick W. Cook & Co., 
      prepared statement of......................................   126
    Pedrotty, Daniel, director, Office of Investment, AFO-CIO, 
      prepared statement of......................................    57
    Powers, Michael, global practice leader for executive 
      compensation and corporate governance, Hewitt Associates, 
      prepared statement of......................................   113
    Reda, James, managing director, James F. Reda & Associates, 
      prepared statement of......................................   130
    Sali, Hon. Bill, a Representative in Congress from the State 
      of Idaho, prepared statement of............................   172
    Scott, Charlie, president of Human Capital Consulting, 
      Mercer, prepared statement of..............................   105
    Shadab, Houman, senior research fellow, Mercatus Center, 
      George Mason University, prepared statement of.............    47
    Waxman, Chairman Henry A., a Representative in Congress from 
      the State of California:
        Majority report..........................................     3
        Prepared statement of....................................    20


          EXECUTIVE PAY: THE ROLE OF COMPENSATION CONSULTANTS

                              ----------                              


                      WEDNESDAY, DECEMBER 5, 2007

                          House of Representatives,
              Committee on Oversight and Government Reform,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
2154, Rayburn House Office Building, Hon. Henry A. Waxman 
(chairman of the committee) presiding.
    Present: Representatives Waxman, Cummings, Kucinich, Davis 
of Illinois, Higgins, Yarmuth, Murphy, Welch, Davis of 
Virginia, Souder, Platts, Duncan, Westmoreland, McHenry, Foxx, 
Sali, and Jordan.
    Staff present: Phil Schiliro, chief of staff; Phil Barnett, 
staff director and chief counsel; Karen Lightfoot, 
communications director and senior policy advisor; Roger 
Sherman, deputy chief counsel; John Williams, deputy chief 
investigative counsel; Brian Cohen, senior investigator and 
policy advisor; Michael Gordon, senior investigative counsel; 
Earley Green, chief clerk; Teresa Coufal, deputy clerk; Caren 
Auchman and Ella Hoffman, press assistants; Leneal Scott, 
information systems manager; Kerry Gutknecht, William Ragland, 
and Miriam Edelman, staff assistants; David Marin, minority 
staff director; Jennifer Safavian, minority chief counsel for 
oversight and investigations; Keith Ausbrook, minority general 
counsel; Ed Puccerella, minority professional staff member; 
Kristina Husar, minority counsel; Larry Brady, minority senior 
investigator and policy advisor; Patrick Lyden, minority 
parliamentarian and member services coordinator; Brian 
McNicoll, minority communications director; Benjamin Chance, 
minority clerk; and Ali Ahmad, minority deputy press secretary.
    Chairman Waxman. The meeting of the committee will please 
come to order.
    Today the committee will be considering the issue of 
executive compensation. Reports of astronomical payouts to 
corporate CEOs have lead many to question the fairness and 
effectiveness of the system for setting executive pay. We will 
be exploring these questions today.
    In the 1980's, the CEOs of the Nation's largest companies 
were paid 40 times more than the average employee. Now they 
make over 600 times more. At a typical company, 10 percent of 
corporate profits--a staggering sum--goes into the pockets of 
the top executives. These huge pay packages raise a basic 
question: Are corporate CEOs working for the company who hire 
them or are the companies working for the CEOs?
    Many academic experts, financial analysts and investors 
believe that soaring CEO paychecks are a symptom of a corporate 
governance system that is not working. As noted investor Warren 
Buffett has commented: In judging whether corporate America is 
serious about reforming itself, CEO pay remains the acid test.
    Today's hearing examines a practice that may be fueling 
this dysfunctional pay system: the use of executive 
compensation consultants with conflicts of interest.
    Executive compensation has become incredibly complex, CEOs 
don't just get salaries anymore. They get stock options, 
restricted stock units, deferred compensation, executive 
pension plans, lucrative severance packages and a vast array of 
perks from corporate jets to tax and financial planning 
services and country club memberships. These compensation 
packages can be worth hundreds of millions of dollars.
    Many companies now rely on the services of professional 
executive compensation consultants to evaluate these complex 
pay arrangements. Last year, in fact, over three quarters of 
the Fortune 250 retained outside compensation consultants.
    Most Americans have never heard of Towers Perrin, Mercer 
and the other influential compensation consultants, but these 
pay advisors can have an enormous impact on executive pay. When 
they do their job right, they can align the interest of the CEO 
with the interest of the shareholder. But when they do their 
job wrong, the result can be vast wealth for the CEO and a 
plundered company for the shareholders and the employees.
    That's why it is so important that these pay consultants be 
independent and free of conflicts of interest. Consultants who 
are paid millions of dollars by a corporate CEO won't provide 
objective advice to the board. They know what the CEO wants to 
hear, and they know what will happen to their lucrative 
contracts if they don't say it.
    For the last 7 months, the committee has been investigating 
conflicts of interest among compensation consultants; and today 
I'm releasing a report that summarizes what the majority staff 
has found. And, without objection, this report will be made 
part of the hearing record.
    [The information referred to follows:]

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    Mr. Davis of Virginia. Mr. Chairman, I would also ask that 
the minority staff response be included in the record as well.
    Chairman Waxman. Without objection, both requests will be 
granted.
    [The information referred to follows:]

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    [GRAPHIC] [TIFF OMITTED] T6535.015
    
    Chairman Waxman. The results of our investigation should 
concern everyone who cares about corporate governance. Over 100 
of the biggest companies in America are using compensation 
consultants with significant conflicts of interest to set CEO 
pay.
    Last year, 113 Fortune 250 companies retained conflicted 
consultants. These consultants typically received $200,000 to 
advise the company about executive pay and over $2 million to 
provide other services, like benefit administration, to the 
company.
    In fact, the consultants are being asked to evaluate the 
worth of the executives who hire them and pay them millions of 
dollars. Like the auditors who signed off on Enron's books, 
they have an inherent conflict of interest. For every dollar 
the consultants are paid to advise on CEO pay, they are being 
paid $11 by the CEO to perform other services to the company.
    What's more, few of these conflicts are being disclosed to 
shareholders. We found that some companies call the consultants 
``independent'' in their proxy statements when in fact the 
consultants were being paid millions of dollars to provide 
other services. And when we looked closely at the conflicts, we 
found that the Fortune 250 companies that use consultants with 
the most extreme conflicts of interest paid their CEOs more and 
raised their pay faster than other companies.
    Today's hearing will give us additional insights on this 
issue. Our first panel includes corporate governance experts 
and institutional investors that have experience identifying, 
assessing and addressing potential conflicts of interest; and I 
thank them for being here today.
    Our second panel consists of the consultants themselves. We 
will hear their side of the story: how they handle conflicts of 
interest and what they do to mitigate their impact. I 
appreciate their cooperation in the committee's inquiry and 
their willingness to appear before the committee today.
    I am disappointed, however, that two leading compensation 
consultants, Watson Wyatt Worldwide and Pearl Meyer & Partners, 
declined our invitation to testify today.
    At bottom, the issue we are examining goes to the heart of 
the executive compensation process. Are soaring CEO pay 
packages earned or are they the result of a rigged process? 
Today's hearing will give us a new perspective on this 
important question.
    [The prepared statement of Chairman Henry A. Waxman 
follows:]

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    Chairman Waxman. I would like to now recognize the ranking 
member of this committee, Mr. Davis.
    Mr. Davis of Virginia. Well, thank you, Mr. Chairman.
    The Enron fiasco reminded us all that corporate 
responsibility and transparency are critical components of a 
healthy capitalist system. Shareholders should have confidence 
in the soundness and independence of key decisions by company 
directors, including decisions on executive salaries, bonuses, 
stock options and benefits. But even after a majority staff 
report issued today I am just not ready to join them in the 
logical leap that presumes a causal connection between the 
services of compensation consultants and any kind of corporate 
malfeasance. It seems we were called here to discuss a problem 
that may not exist and one this committee can't solve, in any 
event.
    The theory goes something like this: Pliant and corrupt 
consultants working both sides of the fiduciary street take 
huge fees for management and recommend unreasonably high 
compensation for those same managers. Company directors, 
unaware of the consultant's conflict of loyalties, blindly take 
the advice; and that's why executive pay has risen so high even 
while company's performance and stock prices fall.
    It is an interesting theory, one steeped in anti-corporate 
populism, but there is little proof that it is true. Instead, 
in a dizzying whirl of fallacious reasoning, the majority first 
presumes an incurable conflict of interest whenever a 
compensation consultant provides advisory services to both the 
directors and the management of the same company. Having thus 
conjured this conflict into existence, it is easy to jump to 
the conclusion that any decision based on such tainted advice 
lacks the requisite independence and fiduciary care.
    It is true the undue influence of compensation consultants, 
like the self-serving opinions rendered by some accounting 
firms, posed a threat to corporate integrity in the past. But 
post-Enron reforms like the Sarbanes-Oxley law put in place 
substantial new safeguards and stiff penalties to induce 
greater transparency and accountability in publicly traded 
companies. Those additional protections and liabilities short-
circuit the majority's theory that consultants cause corporate 
misbehavior and that only additional regulation can fix the 
problem.
    If there is a problem with the amounts or methodologies of 
executive pay, it is the legal and fiduciary duty of corporate 
directors to solve it. No amount of additional disclosure by 
compensation consultants would alter or abrogate the 
fundamental responsibility of corporate directors to make 
timely and informed decisions in the best interest of 
shareholders.
    As Mr. Shadab in his testimony today from George Mason 
University in my district notes, that to be able to capture a 
board, a manager would have actually be employed by the 
corporation to establish the close ties, but CEOs promoted from 
within the company earn about 15 percent less than CEOs hired 
from the outside and that this premium for external hires 
actually grew throughout the 1970's, 1980's and 1990's. But if 
entrenched managers are unduly influencing compensation 
decisions of the board, then why do CEOs without the ability to 
capture directors earn more? Good question.
    If there is a problem with the amounts of methodologies, it 
is the legal and fiduciary duty of the corporate boards of 
directors to solve it, as we noted before.
    Last year, the Securities and Exchange Commission 
considered and rejected the compensation consultants' 
disclosures abrogated here today by the majority and some of 
our witnesses. Why did they do this? Because the Commission 
found the attempt to regulate consultants like accountants 
inept and unworkable. The SEC concluded the proposed disclosure 
could do more harm than good if the information betrayed 
corporate strategy or otherwise caused competitive harm in the 
public realm.
    Ironically, the Commission's concerns about irresponsible 
disclosures were borne out this morning. Sensitive, company-
specific information provided this committee by compensation 
consultants is included in the majority staff report. 
Shareholders in those companies have cause to be concerned 
about the gratuitous, potentially damaging revelation of 
corporate policy in regulatory compliance practices.
    Demonizing executive pay won't cure corporate ills or 
strengthen the performance of company stocks held by pension 
funds covering millions of Americans. Nor should envy or false 
egalitarianism be allowed to repeal the laws of supply and 
demand.
    Recent evidence suggests corporate executive compensation 
levels reflect market forces and correlate with company growth 
and increase stock volume. High turnover in America's top 
executive suites also seems to prove that those who abuse the 
system or fail to perform are replaced with or without a 
consultant's help.
    Mr. Chairman, I agreed when you said management of Federal 
Government funds and programs demanded our full attention, so 
while I appreciate the information our witnesses will provide 
today, I hope we can take the lessons that the private sector 
has to teach and refocus our oversight on that important work.
    Thank you.
    [The prepared statement of Hon. Tom Davis follows:]

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    Chairman Waxman. Thank you, very much, Mr. Davis.
    I do want to call on other colleagues that are here today. 
Ordinarily, just the two of us make opening statements, but if 
either of the other Members that are here wish to make opening 
statements I will recognize them.
    Mr. Davis of Illinois. I have no statement.
    Chairman Waxman. I want to introduce our first panel:
    Charles Elson, Edgar S. Woolard, Jr., Chair in Corporate 
Governance and director of the John L. Weinberg Center For 
Corporate Governance at the University of Delaware's Lerner 
College of Business and Economics. Meredith Miller is the 
assistant treasurer for policy for the State of Connecticut 
Treasurer's Office. Daniel F. Pedrotty is the director of the 
AFL-CIO Office of Investment. Houman Shadab is a senior 
research fellow in the Mercatus Center's Regulatory Studies 
Program.
    We are pleased to have each of you here today, and I thank 
you for being here.
    It is the practice of this committee that all witnesses 
testify under oath, so I would like to ask if you would stand 
and please raise your right hands.
    [Witnesses sworn.]
    Chairman Waxman. Thank you.
    The record will indicate that each of the witnesses 
answered in the affirmative.
    And what we'd like to now do is hear from you. Your written 
statements will be made part of the record in full. We'd like 
to ask each of you to try to limit the oral presentation to 5 
minutes. We will have a clock, and it will be green, and the 
last minute it will be yellow and then red when the 5 minutes 
are up. When you see red, I hope you will conclude.
    Mr. Elson, why don't we start with you. There is a button 
at the base of the mic. Be sure to press it in so we can hear.

   STATEMENTS OF CHARLES ELSON, JOHN L. WEINBERG CENTER FOR 
CORPORATE GOVERNANCE, UNIVERSITY OF DELAWARE; MEREDITH MILLER, 
 ASSISTANT TREASURER FOR POLICY, CONNECTICUT STATE TREASURER'S 
 OFFICE; DANIEL PEDROTTY, DIRECTOR, OFFICE OF INVESTMENT, AFO-
   CIO; AND HOUMAN SHADAB, SENIOR RESEARCH FELLOW, MERCATUS 
                CENTER, GEORGE MASON UNIVERSITY

                   STATEMENT OF CHARLES ELSON

    Mr. Elson. Thank you.
    The problem with executive overcompensation is quite simple 
in its origins and solution. You see, high compensation leaves 
me totally voiceless.
    Pay unrelated to performance is the result of the failure 
of effective bargaining between the corporate board and 
management. The elements leading to this failure are, first of 
all, overreaching management and, second, passive, management-
dominated directors often advised by sometimes compromised 
compensation consultants.
    The key to the solution is to stimulate better bargaining 
between the board and management. I think this can be 
accomplished by insisting that the board, and particularly the 
members of the board's compensation committee, negotiate with 
executive on pay, be comprised of individuals who are 
completely independent of management and hold personally 
meaningful equity stakes in the business itself. This will 
ensure that they have the objectivity and incentive to 
effectively negotiate pay.
    Additionally important to the solution and I think the 
subject of the hearing today are reforms in the ways in which 
compensation consultants aid in the pay compensation process.
    Traditionally, the consultant was hired by management to 
aid in the design and review of the executive pay package. 
Often, the consultant's firm was also engaged to do a 
significant amount of other work for the company. Additionally, 
it was believed that the presence of the consultant provided 
some legal protection to the board who ultimately approved the 
compensation package.
    As a third-party, non-company employee, the consultant was 
supposed to add some objectivity to the process that could be 
effectively relied upon by the board in the review of the 
compensation package. However, because the consultants were 
hired by management and often did other highly compensated work 
for the company, their objectivity as to their review for the 
board of the comp agreement was either factually or certainly 
optically compromised. That's why corporate governance 
advocates have long suggested that the best practice in this 
case would be that the consultant who advises the compensation 
committee be hired exclusively by the committee and perform no 
other tasks for the company or its management. The idea was 
that directors who negotiate pay must receive completely 
unfettered and objective advice from outsiders solely 
responsible to the committee and full board, uncompromised by 
managerial relationships.
    This advice presented to independent and motivated 
directors I think would ultimately result in effective 
incentive pay for the company's executives. At minimum, 
certainly the optics of such a process would be much more 
appealing to the shareholders, aiding in the restoration of 
pubic confidence in the integrity of our business institutions.
    Now this approach, similar to that taken with regard to 
outside company auditors under Sarbanes-Oxley, has been 
endorsed by numerous business and investor organizations, 
including the National Association of Corporate Directors, and 
is supported by many in the financial community. In fact, Chief 
Justice Veasey of the Delaware Supreme Court, the Nation's 
leading appellate business court, in widely quoted remarks made 
at the University of Delaware a couple of years ago stated, 
that compensation committees should have their own advisers and 
lawyers. Directors who are supposed to be independent should 
have the guts to be a pain in the neck and act independently--
suggesting judicial support for this theory.
    Now, the trend today, given the obvious logical appeal of 
this approach and widespread shareholder support, the trend of 
which I have been familiar as a director and academic 
specializing in the area, has clearly been for board comp 
committees to engage their own compensation consultants who 
provide no other work for the enterprise. From a Federal 
regulatory standpoint, I think to further board adherence to 
this best practice, better disclosure on compensation 
consultant conflicts of interest needs to be provided to the 
investors.
    While at present the Securities and Exchange Commission 
mandates disclosure to investors of the identity of a company's 
comp consultant and certain other retention details, there must 
also be disclosure of any other services the consultant 
provides to the organization, as well as the amount of fees 
paid to that consultant, similar to the required disclosure 
regarding the company's outside auditors. This disclosure, I 
think combined with public pressure and the resulting trend 
toward the use of non-conflicted consultants, I believe will 
lead to improved pay practices and a greater confidence by the 
investing public in the integrity of our public corporations.
    Chairman Waxman. Thank you very much, Mr. Elson.
    [The prepared statement of Mr. Elson follows:]

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    Chairman Waxman. Ms. Miller.

                  STATEMENT OF MEREDITH MILLER

    Ms. Miller. Good morning, Chairman Waxman, Ranking Member 
Davis and committee members. Thank you, Mr. Chairman, and your 
staff for your leadership on this important issue.
    My remarks this morning cover the findings of an investor 
initiative led by Treasurer Denise Nappier on compensation 
consultant independence. This initiative was launched in 
response to the SEC's failure to require in its new disclosure 
rules that companies disclose whether a compensation consultant 
worked for both the board and the management of the same 
company. The results of the investor initiative showed that 
compensation committees were willing to exceed SEC's reporting 
requirements and address the issue of independence of 
consultants in the proxy statements, with many adopting formal 
policies.
    With these findings, we urged the SEC to revisit this issue 
and to take steps that a best practice cannot do, that is, 
issue new rules that require companies to disclose all 
compensation consultant business relationships and the fees 
paid by the company for these engagements.
    The independence of compensation consultants is important 
to investors because of the influential role consultants play 
in advising boards on executive compensation. And, in turn, 
executive compensation is important to investors because of the 
ability to serve as a window into board accountability. It can 
show the quality of the decisions and the dynamics of the 
board, and it can show whether those decisions align the 
company interests with shareholders to create long-term, 
sustainable value.
    Unfortunately, we continue to see executive levels of pay 
rising and rewards for poor company performance. Investors have 
responded with various strategies, including 60 shareholders 
proposals filed last year calling for an investor advisory vote 
on pay packages known as ``say on pay.'' The House responded as 
well by passing legislation this year that would give investors 
this right.
    With these trends and events, it follows that, whether it 
be perception or real, investors are concerned that consultants 
who earn more from providing services to management while at 
the same time providing services to the board's compensation 
committee may be biased in decisions related to executive pay 
in order not to lose the lucrative engagements.
    We can agree that management would have a conflict of 
interest if it decided its own compensation. That's why 
shareholders seek to meet with the compensation committee 
members and not management of the company.
    Executive compensation is one issue that comes before a 
board where such a conflict needs to be avoided, and the same 
principle applies if you can consider consultants paid by 
management as an agent of management. In 2006, when the SEC 
announced its intentions to propose new rules for executive 
compensation disclosure, Treasurer Nappier immediately issued 
an open letter to compensation committee members cautioning 
them about the need to be prepared for the increased scrutiny 
such disclosure would bring. The Treasurer highlighted the need 
for this disclosure, harkening back to the auditor consulting 
controversy pre-Enron.
    When the SEC issued its final rules, it acknowledged 
comments from investors urging this disclosure, but ultimately 
it deferred to the consulting community that investors should 
rely on the business judgment of the competition committees and 
that would suffice.
    The Treasurer then embarked on the compensation consultant 
initiative in October 2006. Along with a coalition of investors 
representing $850 billion, the Treasurer wrote to the top 25 
companies in the S&P to ask whether compensation consultants 
did work for both the board and the company and to ask if the 
company would consider adopting a formal policy on compensation 
and consultant independence that prohibited work for management 
in the 2007 CDNA.
    In response to the October letter, we received 18 replies 
and identified the top 10 best practices and sent those 
practices back to the companies so that the compensation 
committees could learn from each other and set a best practice 
for 2007 CDNA. When we examined the 2007 CDNAs of the top 25, 
we found that the vast majority, 23 out of 25, addressed the 
issue of independence, thereby exceeding the SEC's requirement. 
Out of the 25, 12 implemented formal policies that promoted the 
fundamental principles of independence, and 11 did no work for 
management. And we learned of several innovative approaches to 
this issue.
    Elements of a best practice included a formal policy 
adopted by the compensation committee which ideally would bar 
work from management, but if management needed survey work data 
on compensation a de minimus test existed. This initiative 
showed that companies were willing and able to exceed the SEC 
reporting standards, but that without clear and uniform rules 
the definitions of independence varied, who made the 
determination varied, and even the decision to disclose on the 
issue varied.
    We urged the SEC to recognize what investors, consultants 
and compensation committees recognize, that investors have a 
right to know if the advice their company receives on executive 
compensation could potentially be compromised by monetary ties 
to the management of that same company.
    Thank you.
    Chairman Waxman. Thank you very much, Ms. Miller.
    [The prepared statement of Ms. Miller follows:]

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    Chairman Waxman. Mr. Shadab.

                   STATEMENT OF HOUMAN SHADAB

    Mr. Shadab. Mr. Chairman and distinguished members, thank 
you for the opportunity to appear here today and testify on 
executive pay and the role of compensation consultants. I am a 
senior research fellow at the Mercatus Center, a research, 
education and outreach organization affiliated with George 
Mason University. The Mercatus Center's mission is to bridge 
academics and policy. We conduct interdisciplinary research in 
the social sciences that integrates practice and theory. My own 
research focuses primarily on securities and financial markets 
regulation.
    My remarks today will focus on, one, the academic law and 
economics literature regarding explanations for increased 
compensation of public company executives and, two, other 
empirical findings relevant to potential conflicts of interest 
among executive compensation consultants.
    The ultimate goal of any system of corporate governance and 
the criterion by which to judge good from bad governance is 
promoting the wealth of shareholders. Today, a corporation is 
primarily governed by its board of directors which is typically 
responsible for setting executive compensation. The New York 
Stock Exchange and NASDAQ listing standards passed in the wake 
of the Sarbanes-Oxley Act of 2002 require a majority of the 
company's board to be independent, and the New York Stock 
Exchange in particular requires wholly dependent compensation 
committees.
    Although setting excessive executive compensation may 
violate directors fiduciary duties to shareholders, 
compensation decisions are made in the ordinary course of 
business and therefore are afforded substantial judicial 
deference under a longstanding pillar of American corporate law 
known as the business judgment rule.
    Currently, there is a dispute among academics as to the 
precise source of the increases in executive compensation that 
took place over the past decades and years. One influential 
line of thought argues that increased CEO compensation is the 
result of entrenched CEOs unduly influencing directors to grant 
themselves excessive pay to the detriment of shareholders. 
While certainly possible, the managerial entrenchment theory 
fails to explain why CEO compensation continued to increase 
even while boards of directors were becoming increasingly 
independent of management at least as far back from 1997 to the 
present.
    Another problem with the entrenchment theory already 
referred in to this hearing was that to be able to capture a 
board a manager should most likely be employed by the 
corporation to establish the requisite close ties with 
directors to capture them. However, empirical evidence shows 
that CEOs promoted from within a company earn about 15 percent 
less than CEOs hired from the outside and that this premium for 
outside hires actually grew throughout the 1970's and through 
the 1990's.
    Just because the managerial entrenchment theory does not 
explain all the data does not mean it is completely wrong. 
However, there are in fact other explanations for increases in 
absolute and relative executive compensation. Indeed, a 
substantial body of recent empirical corporate governance 
research finds that executive compensation is primarily the 
result of increased value of corporate assets, increased 
competitive pressures faced by executives in corporations and 
increased liability and regulatory risk stemming from passage 
of the Sarbanes-Oxley Act.
    As former Labor Secretary Robert Reich has noted, our CEO 
compensation does not reflect social or moral worth. Increased 
CEO pay is best explained not by the impingement theory but by 
boards of directors choosing their CEOs from a relatively small 
pool of executive talent and that today ``under super-
competitive capitalism, boards are willing to pay more for CEOs 
because their rivals are paying more and the cost of making a 
bad decision is so much greater than it was decades ago when 
competition for investors and customers was far less intense 
and shareholders were far more placid.''
    Indeed, a recent study by the Federal Reserve on 
compensation from 1936 to 2005 concluded that compensation 
arrangements have served to tie the wealth of managers to firm 
performance and perhaps to align managerial incentives with 
shareholders' interest for most of the 20th century.
    Further, the rise in income inequality between top earners 
and average employees can perhaps be explained by technological 
progress raising the productivity of skilled workers more than 
it raises the productivity of less skilled workers. For 
instance, e-mail and videoconferencing have arguably helped 
executives add more value to their day-to-day activities than 
factory workers.
    Taken as a whole, many studies deeply call into question 
the assumption that increased executive compensation eats into 
corporate profits and thereby hurts investors. Indeed, they 
suggest that current levels of executive pay largely reflect 
the benefits that good CEOs create for shareholders.
    Regarding potential conflicts of interest or a lack of 
independence of compensation consultants who also provide 
noncompensation services, I simply want to draw the committee's 
attention to the empirical record on the provision of nonaudit 
services that the wrong lesson is not learned. Although 
corporate governance reform such as the Sarbanes-Oxley Act 
prohibits auditors from providing nonaudit services to audit 
clients, empirical records strongly supports a view that audit 
independence is not jeopardized by providing nonaudit services.
    In a 2005 review of the empirical literature regarding the 
provision of nonaudit services, Yale law professor Roberta 
Romano found that the overwhelming majority of the numerous 
studies on the issue found no relationship between audit 
quality and the provision of nonaudit services; and, in fact, 
three studies found that auditors providing nonaudit services 
actually improved audit quality. In addition, in 2006, yet 
another academic study found that the provision of nonaudit 
services improves audit quality.
    A general reason why providing nonaudit services may 
improve audit quality is because auditors benefit in their 
auditing work from so-called knowledge spillovers. The 
knowledge auditors gain about the company from providing 
nonaudit services may enable them to conduct a more effective 
audit. The provision of noncompensation services may similarly 
have no or even a positive impact on compensation decisions.
    I would like to again thank the committee for inviting me 
to share my views.
    Chairman Waxman. Thank you very much.
    [The prepared statement of Mr. Shadab follows:]

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    Chairman Waxman. Mr. Pedrotty.

                  STATEMENT OF DANIEL PEDROTTY

    Mr. Pedrotty. Good morning, Chairman Waxman and Ranking 
Member Davis and members of the committee. My name is Dan 
Pedrotty. I'm the director of the Office of Investment at the 
AFL-CIO representing more than 10 million members and their 55 
national unions. We commend your leadership on this issue and 
inquiry into the provision of biased advice by compensation 
consultants.
    Consultants and Boards of Directors remain unaccountable, 
while CEO pay continues reach dizzying heights. Last year, the 
average S&P 500 CEO received almost $15 million in 
compensation, a 9\1/2\ percent hike from 2005. Directors 
overcharged with seeing and protecting investors and forcing 
and negotiating arms-length pay packages seem resigned to a 
pay-for-failure status quo. Two-thirds of directors believe 
``that their boards are having trouble controlling the size of 
CEO compensation.''
    Outsized pay packages for senior executives hurt 
shareholders, including pension plans investing the retirement 
savings of America's working families. Union members 
participate in benefit plans with over $5 trillion in assets, 
and union-sponsored plans have assets of over $350 billion. 
Outrageous pay packages are giveaways of our members' money.
    One of the cruelest ironies of the current housing crisis 
is that while hundreds of thousands of Americans are losing 
their homes, CEOs of financial institutions that steered 
borrowers into risky loans or traded in sub-prime mortgages may 
walk away with hundreds of millions of dollars.
    In October, 1 in every 555 households is facing 
foreclosure. Yet CEOs of the 16 largest financial services 
companies involved in the subprime crisis could collect more 
than $1 billion in total compensation if they are forced from 
their job, according to the Corporate Library.
    Already, former Merrill Lynch CEO Stan O'Neal has walked 
away with over $161 million; Angelo Mozilo, the chief executive 
of Countrywide, stands to gain $75 million if he is forced out; 
and Richard Fuld of Lehman could collect nearly $300 million in 
severance as a result of his dismissal.
    For each overpaid CEO who contributed to the subprime 
mortgage crisis, there is likely to be a conflicted comp 
consultant who designed the pay package. Consider Merrill 
Lynch, where the firm Towers Perrin has advised the board's 
compensation committee since 2003. According to the company's 
2007 proxy, Towers Perrin also provides consulting services 
that are not related to executive compensation; and we believe 
this dual role endangers the impartiality of consultants.
    A recent study confirms investors' worst suspicions. 
Companies that use comp consultants tend to pay their CEOs 
higher salaries without better performance. Companies that used 
4 of the 10 larges firms biggest firms--Pearl Meyer, Towers 
Perrin, Hewitt and Mercer--paid salaries 15 percent or higher 
than the average CEO pay.
    Mr. Chairman, I believe the report that you put out this 
morning adds even more grist to the mill here. The problem is 
that there are no safeguards in the system to assure 
independence. All too often, the firms hired to ensure that the 
executive pay is appropriate earn enormous fees for the 
consulting work that they are hired to do for the company.
    Consider the role that Hewitt played at Verizon. As 
Verizon's comp consultant, CEO Ivan Seidenberg received over 
$19 million in 2005, which was 48 percent higher than the prior 
year, while at the same time the company's stock fell 26 
percent and earnings fell 5.5 percent. A New York Times article 
last year disclosed the fact that Hewitt from 1997 until the 
present time of 2005 provided consulting services worth over 
half a billion dollars in fees from employee benefits and HR 
services to the company. Not surprisingly, Verizon became the 
first public company where shareholders demanded a say on pay.
    Now worker funds also with other governance initiatives at 
Verizon during this proxy season. The Communications Workers of 
America filed a compensation consultant proposal that insisted 
that the company disclose the relationship of the compensation 
consultant and their relative independence or lack thereof. The 
proposal received a strong vote. It got over 46 percent, and 
we're pleased that Verizon last month agreed to a policy that 
would ban the comp consultant from doing other work for the 
company.
    While encouraged with the efforts of companies to 
voluntarily adopt policies of independence, more must be done. 
Consulting work should be limited to advising company boards so 
pay packages are geared to incentivize long-term-value 
creation. As a first step, the SEC should require companies to 
disclose the total dollar amount paid to consultants and the 
amount paid for advice provided to the board of directors.
    The conflicts of interest that compromise an impartiality 
of comp consultants do parallel the auditor independence 
concerns that led to the passage of Sarbanes-Oxley. Like audit 
firms prior to SOx, comp consultants performed lucrative 
consulting work unrelated to the investor protection role they 
are supposed to play. Investors need new standards for comp 
consultant independence, just as Sarbanes-Oxley created for 
auditor independence.
    In that context, while disclosure is an important first 
step, we as investors need the tools to hold consultants 
accountable. Our funds currently vote on auditors at annual 
meetings, and the movement behind the say on CEO pay at annual 
meetings is gaining momentum.
    Given the scope of conflicts as detailed in this report 
this morning and the central role of consultants in pay for 
failure, we believe an up-or-down vote on the company's 
compensation consultant in any context where a conflict exists 
would be appropriate.
    I again thank you, Mr. Chairman, and would be happy to 
answer any questions.
    Chairman Waxman. Thank you very much, Mr. Pedrotty.
    [The prepared statement of Mr. Pedrotty follows:]

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    Chairman Waxman. I want to start off the questions.
    Many experts have suggested that compensation consultants 
have contributed to the traumatic rise of CEO pay over the last 
several years. They argue that compensation consultants as a 
whole are directly responsible for some of the most pernicious 
and costly developments in executive pay.
    One well-respected investor, Warren Buffett, has stated, 
``Too often, executive compensation in the United States is 
ridiculously out of line with performance. That won't change 
moreover because the deck is stacked against investors when it 
comes to the CEO's pay. The upshot is that a mediocre or worse 
CEO, aided by his handpicked vice president of human relations 
and a consultant from the ever-accommodating firm of Ratchet, 
Ratchet & Bingo, all too often received gobs of money from an 
ill-designed compensation arrangement.''
    In the report that I released today, we surveyed the 
leading compensation consultants and found that over 100 of the 
largest companies in America have higher compensation 
consultants that have significant conflicts of interest. I want 
to ask whether you think these conflicts of interest are a 
serious problem.
    Professor Elson, you've studied this issue as both a 
corporate director and professor. Are you concerned about these 
conflicts and how widespread they are and do you believe these 
conflicts are having an impact on the levels of CEO pay?
    Mr. Elson. Well, first of all, I am very concerned about 
the conflicts, I think in several regards.
    No. 1, what the question is, do the conflicts in interest 
actually ration a pay? And I think that, frankly, given the 
subjective nature of the way pay is put together, there is no 
clear objective standards on pay. It is not a body of law that 
you apply. There is a lot of subjectivity to the process. And I 
think that, given that and given these other relationships, 
there is certainly the potential to be influenced by those 
other relationships in what you are recommending. And I think 
that is clear and there is no way around that.
    The question is, I guess once you establish that, is where 
do you go from there with it? What in fact do you do about it? 
Does it in fact create higher pay?
    Well, let's assume that--the worst possible case would be, 
obviously, someone who was directly compromised by the 
relationship and recommended a higher package based on those 
subjective factors. That's problem one.
    Problem two is someone who, using those subjective factors, 
has been influenced by those relationships; and that to me is 
actually the real problem. It is much more subtle than a direct 
``I will give you other business if you recommend a higher 
package.'' It is much more subtle and again, because of the 
subjectivity involved, more subject to abuse.
    The third reason is the optical reason to the investors, 
and this is where I am really concerned as well. Because to the 
investor the presence of the compromise consultant, the 
resulting pay will always be challenged and questioned. As a 
director, why would you want to put yourself in that position 
vis-a-vis your investors, saying to them, well, we used a 
compromised consultant or a consultant with other 
responsibilities, but it's OK, don't worry, trust us.
    Chairman Waxman. Yes.
    Mr. Elson. I think the optics, frankly, aren't all that 
good; and that's why I think that separating the two out--
consultancy from the actual pay advice--is warranted here.
    Chairman Waxman. Let me ask some other questions of the 
panel.
    Ms. Miller, you're responsible for managing Connecticut's 
pension fund, so you approached this as an investor. Are you 
concerned about these conflicts of interest? Do you believe 
they are affecting the levels of CEO pay and therefore we ought 
to be concerned about it?
    Ms. Miller. Yes, Mr. Chairman, we are very, very concerned. 
In fact, this is an issue the Treasurer has written to the SEC 
on, just this issue about asking for disclosure. That's how 
concerned we have been.
    I think that we continue to see problems in rising 
executive compensation. There has been a blackout on 
information without knowing whether the consultants are 
conflicted in the SEC disclosure. It has been very difficult 
for investors to be able to even begin to figure out how much 
of the executive pay increases could be attributed to 
conflicted and compromised consultants.
    Chairman Waxman. Well, for many people, investors and the 
public alike, they look at the pay for the executives and there 
seems to be a disconnect often between the pay and the 
performance of the CEOs. Do you think this is one of the 
reasons we have this disconnect?
    Ms. Miller. I think you're asking exactly the right 
question. When you sort of peel the onion and you look at the 
role the consultant plays, there are key elements of the 
executive compensation package, like the peer group that is 
chosen, the benchmarks that are used for performance. These are 
the elements within the compensation package that could 
contribute to ratcheting up of pay and how you set those 
performance goals amongst the peers that are chosen.
    Oftentimes, compensation committees get both the data that 
supports the peer group and the data on other comparative 
measures from the consultant; and it is our concern that, when 
you sort of take a closer look, these pieces that contributed 
to the ratcheting up of pay are pieces that for us we would 
feel more comfortable and have a lot more investor confidence 
if they were associated with an independent consultant.
    Chairman Waxman. Now, one of the findings of the committee 
in the report released today is that companies are failing to 
provide adequate disclosure of conflicts of interest to 
investors and the public. The committee identified 113 cases 
where compensation consultants used by Fortune 250 companies 
had conflicts of interest but the proxy reports filed by the 
companies only disclosed those conflicts for about 25 percent 
of the companies. So the vast majority of the Fortune 250 
companies are not disclosing their use of pay advisors with 
conflicts.
    Mr. Pedrotty, what's your reaction to this finding?
    Mr. Pedrotty. We think that's particularly troubling, Mr. 
Chairman, and another example of the how the Securities and 
Exchange Commission betrayed investors by not going far enough 
in their disclosure rules. We think just by naming the 
consultant we are not getting enough transparency and 
disclosure and that when investors are evaluating pay packages 
they should have all the information.
    So, again, the analogy that's used all the time by CEO pay 
apologists is this is much like movie stars or sports stars in 
terms of escalating pay, but it's fundamentally different in 
that this is not an arms-length negotiation. It is not arms-
length in the people who are negotiating or the people who are 
advising the negotiators. That's why we have two-thirds of 
directors, our representatives, saying we ourselves can't get a 
handle on this problem.
    Chairman Waxman. The lack of disclosure of this information 
is a problem, and we pointed that out and seemed to agree to 
that. In some cases, it seems like companies may be providing 
inaccurate information about their consultants. The committee 
report found that in 30 cases where Fortune 250 firms hired 
consultants with conflicts of interest, the firm described 
their consultants as ``independent.'' If a Fortune 250 firm 
hires a consultant to provide executive compensation advice and 
company management also pays that consultant millions of 
dollars for other services, do you think it is misleading for 
the firm to describe their consultant as ``independent?''
    Mr. Pedrotty. We think it is absolutely misleading, Mr. 
Chairman; and we think the core problem here is a consultant 
isn't going to want to alienate the person who is going to 
award them significant amounts of other business. I think, as 
your report shows out, that's a multiple of sometimes 40 to 50 
times. And in some cases it is not only awarding them business 
with the company for actuarial services or HR consulting, it's 
also if the CEO is chairman of the board, the CEO himself is 
hiring the pay consultant who will decide his or her own pay. 
So we think that's a problem.
    Transparency is the first step, but we ultimately think, 
much like the fight around equal access to the proxy, that 
investors need the tools to hold their representatives 
accountable.
    Chairman Waxman. I know some people feel this problem 
should be left to the market, but if there is a problem with 
conflicts, companies will hear about it from investors and will 
take action to stop it. But markets can't function without good 
information. It is clear that companies are not providing 
necessary information about their compensation consultants' 
conflict of interest.
    Ms. Miller, can you make well-informed decisions about 
companies when they fail to provide information about conflicts 
or, worse, when they provide information that appears to be 
misleading?
    Ms. Miller. Yes, I think that is--no, it is very difficult 
to make good, informed decisions about compensation and 
compensation consultants' advice when the information may be 
misleading.
    I think the problem that we saw was that the definition of 
independence varied; and oftentimes the compensation committee 
would assert that it was, in their judgment, based upon their 
relationship and their past history with the consultant, that 
they believed that the consultant was independent. Without some 
kind of standardized definition and standardized reporting, it 
is very difficult for an investor to be able to determine 
exactly what that relationship is, what their definition of 
independence is.
    Chairman Waxman. Thank you very much.
    Mr. Davis.
    Mr. Davis of Virginia. Thank you, Mr. Waxman.
    Mr. Shadab, let me start with you. Are you aware that the 
consulting firms that only advise on executive compensation are 
generally associated with the corporations that had the highest 
levels of executive pay?
    Mr. Shadab. I was not aware of that fact, no.
    Mr. Davis of Virginia. Well, that is a fact, which kind of 
negates the whole thesis of this today. It negates the thesis, 
which is the basis of the hearing.
    Isn't it far more threatening financially for a firm that 
would advise only an executive compensation to lose a client 
than it was for a larger firm with multiple lines of consulting 
business?
    Mr. Shadab. Is possibly could be, yes.
    Mr. Davis of Virginia. Mr. Elson, you serve as a board 
member on several public companies, is that correct? In this 
capacity, have you been involved in improving executive 
compensation packages?
    Mr. Elson. Yes, sir.
    Mr. Davis of Virginia. Now are you testifying today that 
your board members are unable to request or do you request from 
your management information relating to the other business 
relationships that a third-party consulting firm has with your 
companies when they are advising you on questions of executive 
compensation?
    Mr. Elson. Well, on the compensation committee that I 
chaired, we in fact brought in an independent consultant. 
Because I believed, as chair of the committee, that the other 
consultant, because they were doing--it came to our attention 
that they were doing other work for the company, it was 
appropriate that we bring in an independent advisor to create a 
better process.
    Mr. Davis of Virginia. But even if you didn't bring in--say 
you weren't chairman of the committee, as a board member you're 
free to ask that information, request that information. In 
fact, it would be appropriate to do so, wouldn't it?
    Mr. Elson. Yes, I do, but I don't think a lot of directors 
ask that question. I would ask that question because it is an 
area as an academic I find interesting, but I don't think most 
do, no, sir.
    Mr. Davis of Virginia. And once you have access to that 
information then you can make a judgment whether it is 
appropriate or inappropriate, right?
    Basically, what we're talking about here is saying 
directors aren't doing their jobs, and so we are scapegoating 
it and putting it out on these independent consultants. But any 
wide-awake director ought to be looking at and asking these 
kind of questions, and you really want to limit their ability 
to get the best advice just because they may have another line 
of business with the corporation.
    Now I think one of the difficulties is we're restricting 
how corporations can get information and who they can get it 
from. Whereas a wide-awake director ought to be asking--I think 
it is certainly entirely appropriate to ask, do you have other 
businesses relations with the firm as part of the 
decisionmaking process. But to restrict it seems to me you are 
hamstringing corporations' ability to get information, and I'm 
not sure that's our job.
    Mr. Elson. I'm not really sure you're restricting it. You 
are simply disclosing it.
    Obviously, the director is free to use a conflicted 
director or not--conflicted consultant or not. I think the key 
is a wise director, in my view, in this day and age, given 
investor pressure and certainly given what we are seeing coming 
out of the legal system, would be well advised to seek out 
independent advice or uncompromised or unconflicted advice. 
Clearly, as director, you can weigh conflicted advice one way 
or another, but to do your job effectively for the investor I 
think you'd want the best possible advice, which in my view is 
nonconflicted.
    Mr. Davis of Virginia. Do you really think the reason 
corporate salaries are so high is because of these compensation 
consultants or do you think there are a lot of other factors?
    Mr. Elson. Oh, I do think there are a lot of other factors, 
but I do think they are a factor. Clearly, a compensation 
consultant misused by a passive, management-dominated board 
will create--and combined with overreaching executives will 
create pay unrelated to performance.
    It is all part of the picture. You have to solve all the 
elements. One is, management will always have an incentive to 
ask for more, but certainly a board, if it is independent of 
management and owns stock in the company, advised by a 
nonconflicted advisor is going to do a better job in my opinion 
than a board of directors--let's say a director who was 
appointed by management, has no independence and has no stake 
in the company.
    Mr. Davis of Virginia. Let me just tell you, the way the 
laws work now, it is hard to get good corporate directors 
because of the liabilities involved. The fiduciary duties of 
corporate directors at this point--I talk to people in the 
private sector. There's a huge reluctance on the part of a lot 
of talented people to go on and make cases because of the 
opportunity of being sued. So you're going to be asking these 
things, it seems to me, if you are any kind of wide-awake 
director. Do you not think that culture is changing--or not?
    Mr. Elson. Well, I chair nominating governance committees 
of two publicly traded companies, and so I'm on the search for 
directors all the time. And I don't think that there is a 
shortage in supply of directors because of the concerns about 
compensation, a compensation issue or whatnot.
    I think the job of the director has become much more 
complex today because, obviously, in the old days you were 
simply an advisor of management, and today you are expected to 
be a monitor for the shareholders, and there is more required, 
more time involved, and certainly the potential of liability is 
greater the more you do.
    I don't think there is a shortage of people who are willing 
to go on board, and I certainly wouldn't believe that changing 
disclosure compensation consultant conflicts would have 
anything to do with the ability to recruit effective directors. 
Frankly, as a director, I would want to be on a board where you 
have as clean a governance package as possible, because that 
makes it much less likely that I will be successfully sued.
    Mr. Davis of Virginia. I don't know that I disagree with 
that. The question is, should Washington mandate it or should 
the corporate boards have the ability to mandate it? And my 
experience has been you are better off probably not mandating 
it. There are a lot of unintended consequences.
    Let me move ahead with it. A full-services consulting firm 
that provides nonexecutive consulting services for a client 
company is going to be I think by definition more familiar with 
the operations of that company than a smaller single-purpose 
boutique firm that specializes just in executive compensation. 
If you would limit executive compensation consulting work to 
such boutique firms you would be depriving compensation 
committees of advice that reflects a more complete 
understanding of respective companies. Now your argument is you 
don't believe that they should be restrictive, you just think 
it should be disclosed, is that fair?
    Mr. Elson. I'm a believer in the market, and I think the 
market itself is pushing us toward using the boutiques, but I 
wouldn't have a government regulation that said you couldn't 
use a full service firm. No, I believe the solution is 
disclosure.
    Mr. Davis of Virginia. Ms. Miller, do you think the 
solution is disclosure or should there be a ban?
    Ms. Miller. I think that, as the first step, we should 
start with disclosure, but in the event that investors continue 
to have concern about escalating executive comp or the quality 
of the disclosure, I think we ought to seriously consider a 
ban.
    I'm reminded of concerns we had about the auditor issue 
back in 2000, prior to Enron, when the SEC promulgated the 
first wave of rules and they were weak. And then we had a 
number of scandals and then they had to issue new rules.
    So I think that this issue is an iterative process, and I 
think it is going to take some time to work through it, but I 
would say that in the very first instance we need the SEC to 
revisit this and require disclosure.
    Mr. Davis of Virginia. Thank you.
    Mr. Shadab, do you think that the analogy between 
compensation consultants and accounting firms is an accurate 
one?
    Mr. Shadab. I think to some extent it is accurate, but it 
is accurate in a way that--you have a third party coming in and 
providing services to management, that could have a potential 
conflict of interest. But I don't think it is accurate in the 
way perhaps some advocates have disclosure or prohibitions on 
not providing the core services that the company provides, 
whether it be auditing or compensation services.
    It is an accurate analogy for the reasons I stated in my 
oral testimony, namely that is there is no good evidence, in 
fact, better evidence in the opposite direction showing that 
potentially conflicted auditors reduce audit quality where in 
fact the empirical studies show that to whatever extent there 
is an actual impact from allegedly or potentially conflicted 
auditors there wasn't improvement in audit quality.
    Now, that analogy I think, to the extent it carries over to 
consultation consultants, could also be the case that a 
compensation consultant providing noncompensation services also 
has, as you are referring to, more knowledge about the company 
and therefore can make more accurate compensation packages for 
executives that do serve the interest of shareholders.
    Now, taking a step back, I think it is important for all of 
our concerns to be driven by empirical data and so, first of 
all, concerns about what services should be prohibited and what 
types of services that company----
    Mr. Davis of Virginia. Let me ask you this. An audit report 
out there, shareholders are going to rely on an audit report, 
not just directors, right?
    Mr. Shadab. Correct.
    Mr. Davis of Virginia. Put an audit report out. 
Shareholders don't rely on that. The directors rely on that in 
setting compensation and use that as one of several factors, 
including the marketplace, to determine bringing someone in. 
Maybe you want a CEO in. Whatever the compensation, if you want 
the right guy, he can negotiate his own price notwithstanding--
--
    Mr. Shadab. Correct. So there is a disanalogy between audit 
services and compensation services, and the primary consumer of 
financial statements are investors, where the primary consumer 
of compensation advice is the board.
    Mr. Davis of Virginia. So the question for us from the 
policy perspective is, are we here to protect the board or are 
we here to protect investors? And it seems to me that we have a 
duty to protect investors out in the marketplace, but I'm not 
sure we have a duty to protect board members.
    Mr. Shadab. Surely you don't, correct.
    Mr. Davis of Virginia. Mr. Pedrotty, let me ask you, do you 
favor disclosure or would you like to have a ban on these kind 
of conflicts?
    Mr. Pedrotty. Congressman Davis, we think disclosure is a 
good start. Clearly, from the report this morning, disclosure 
is a long way from being adequate for investors. We think that 
separating the role of consultant advising the board and 
advising the company is the best practice already. We have 
already found companies like Proctor & Gamble, Wachovia and 
Verizon taking that lead. So we think that if that's the best 
practice and you have other institutions like the National 
Association of Corporate Directors and the conference board 
leading in a similar direction, we think others should follow.
    Finally, Congressman Davis, we think that a vote is 
appropriate here.
    To go back to you earlier question about the auditor issue, 
for our markets to be at their competitive best, information is 
key. We don't have information and, much like the auditor, 
shareholder confidence in pay and pay for performance is 
eroding. So I think from an investor protection standpoint we 
have a long way to go. Disclosure is the first step, but there 
are other steps.
    Mr. Davis of Virginia. But the compensations are disclosed, 
aren't they?
    Mr. Pedrotty. The compensations are disclosed, but we 
still--on comp consultant independence and conflicts, we still 
have a way to go.
    Chairman Waxman. Thank you, Mr. Davis.
    I want to now recognize Mr. Danny Davis.
    Mr. Davis of Illinois. Thank you, Mr. Chairman.
    Many Americans have no idea what a compensation consultant 
does and what kind of impact they have on the explosion in CEO 
pay. Some may understand that if you need a consultant to 
determine your pay that you're doing pretty good. But few 
people outside of the investment world really understand what 
they do.
    Experts on corporate governance are different. They 
understand who these consultants are and what role they play. 
And there is a consensus among these experts that conflicts of 
interest are a serious issue. The Conference Board, the 
National Association of Corporate Directors, the Business 
Roundtable and the New York Stock Exchange have all expressed 
concerns. Yet they all express the view that corporate boards 
should strive to avoid hiring consultants who have been awarded 
lucrative contracts by CEOs they are supposed to be evaluating. 
Despite the recommendations of these experts, the report 
released today found that over 100 of the Fortune 250 companies 
are using consultants with conflicts of interest.
    Professor Elson, you are active on corporate boards. Have 
corporate boards been too slow to respond to this red flag? And 
if so, why do you think so?
    Mr. Elson. I think for a long time people really didn't 
think about it. I think several factors were at play.
    No. 1, a lot of boards were dominated by management. And, 
frankly, the compensation consultant legally was a great thing 
to have for a director, because it protected you legally. The 
problem with the use of compensation consultants really comes 
from sort of a legal view that the use of the consultant 
protects the director from a State law challenge against the 
director's actions. The fact that you had a third-party advisor 
was considered helpful to you legally. And that explained the 
proliferation.
    And I think that initially a lot of directors, obviously 
dominated by management, were happy to have that protection 
and, frankly, didn't question it. And I think what's happened 
now, as we began to think about it and look at compensation 
under the microscope and following the scandals of the last 
couple of years, realize that we really do have a problem vis-
a-vis managerial--I've got to say in many companies, some 
companies--managerial integrity. There's a real concern. And 
based on that concern, there's a real re-examination of all 
processes that boards go through, including compensation. And 
obviously, given investor concern, there's a heightened 
interest in it. And I think that's why it explains the shift.
    I think also, legally, the courts of Delaware, for 
instance, are beginning to shift in their definition of 
independence and the use of independent advisors. That's why I 
included in my testimony the comments of the chief justice of 
Delaware on the necessity of an independent advisor to the comp 
committee.
    And as a director, having an independent advisor I think is 
not only smart from an investor's standpoint, it's smart from a 
legal standpoint. And I've got to tell you, as a director, to 
knowingly, intentionally keep on a conflicted comp consultant 
in the presence of investor pressure would be almost moronic. 
There's absolutely no reason to do it. And I think, at that 
point, we've begun to see a shift in practice, and I think it's 
a valued shift. But I think, for a long time, people didn't 
think about it.
    Mr. Davis of Illinois. Thank you very much.
    Mr. Pedrotty and Ms. Miller, what are your views? And are 
corporate boards acting responsibly when they hire compensation 
consultants, knowing that there are conflicts of interest?
    Mr. Pedrotty. Go ahead.
    Ms. Miller. Thank you, Dan.
    I do believe that corporate boards are not acting 
responsibly when they're hiring compensation consultants when 
they know that there's a disproportionate monetary tie to the 
management side and that they're supposed to be consulting to 
the committees in the best interest of both the company but 
also of shareholders. And the board members are supposed to 
represent shareholders' interests. And so, that conflict can't 
work well for our interests, the investors to be represented.
    I think that, in our study, when we approached the 25 top 
companies, we engaged the compensation committee chairs. And 
when we brought to their attention this issue and the concern 
about the conflict of interest that investors had, they were 
willing to positively address the issue of independence. I 
think that it is surprising there has been a lag within 
compensation committee chairs of corporate America.
    But I do believe that brought to their attention, through a 
required disclosure, we can really get away from really hoping 
that the market will take care of this and hoping that this 
will just be a best practice. I don't think we, as investors, 
can tolerate this issue to just continue to be a best practice. 
I think that we cannot tolerate conflicts of interest and 
definitely need a disclosure standard.
    Mr. Pedrotty. Just to followup, Congressman Davis, I think 
the situation is getting better. I mentioned some companies 
that were engaging in best practices. But we still have a long 
way to go.
    And something that was pretty representative for us is we 
joined with the investor coalition led by Connecticut and sent 
letters to directors, asking for more disclosure. A number of 
companies in the S&P top 25 didn't even respond to the letter. 
So I think we've got a challenge in making directors more aware 
that this is part of their fiduciary duty and educating 
companies.
    And we're interacting with companies almost on a one-on-one 
basis by filing shareholder proposals, but we continue to see 
glaring and egregious examples. One was last year at Wal-Mart, 
which, from our standpoint, is a pay-for-failure company, a 
pay-for-pulse company. The company was surprised at our outrage 
at the fact that their management hired the comp consultant and 
not the board. They didn't understand why we would be concerned 
about that as a potential conflict.
    So there are leaders, but we still have a long way to go, 
just getting that information and then having the standard 
brought up through the SEC.
    Mr. Davis of Illinois. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Waxman. Thank you, Mr. Davis.
    Mr. Westmoreland.
    Mr. Westmoreland. Thank you, Mr. Chairman.
    And, Mr. Pedrotty, you made a comment a while ago about the 
executive pay, the majority staff report, the executive pay. 
That was embargoed until 10 a.m., and you were sitting there at 
10 a.m. How did you get a copy of that?
    Mr. Pedrotty. Mr. Westmoreland, I was reacting to the 
comments of the chairman on the information within the majority 
staff report.
    Mr. Westmoreland. OK. So I guess it wasn't embargoed to the 
public? Or did he just want to give it to the witnesses to--
would that bias your statement in any way, that you got a copy?
    Mr. Pedrotty. No. The statement I brought----
    Mr. Westmoreland. It wouldn't? Even though you commented on 
it and quoted from it?
    Mr. Pedrotty. I think that adds further concern on the part 
of investors. And there was a Corporate Library study that 
looked at comp consultants and companies and found that 
companies that retained these consultants paid higher than the 
median without better performance. I think this is a different 
cut on that, so I was accentuating information I already had in 
my statement.
    Mr. Westmoreland. I'm wondering, Mr. Chairman, whether we 
could get a copy of who all got advanced copies of the report.
    The other thing: Mr. Pedrotty, you are the director of the 
investment office for the AFL-CIO. Is that correct?
    Mr. Pedrotty. That's right.
    Mr. Westmoreland. It says here that the union-sponsored 
pension plans holds more than $450 billion in assets.
    Mr. Pedrotty. That's right.
    Mr. Westmoreland. Do you have a compensation plan? Or could 
I ask how much you make?
    Mr. Pedrotty. How much do I make? Actually, Mr. 
Westmoreland, I think we practice what I preach, in that what I 
make is not just publicly available--it's a little bit over 
$110,000--but every single employee in every single labor union 
has disclosed what their salary is to the Department of Labor. 
So if we had commensurate disclosure at companies, it would be, 
you know, quite an improvement.
    Mr. Westmoreland. Is that based on performance of what 
these assets do?
    Mr. Pedrotty. It's based on advising our pension plans 
around best practices in corporate governance. And we feel like 
we've got a long way to go. We've been successful at some 
companies like Pfizer and Home Depot and Verizon, so I think we 
feel good about our success, but there's lots more challenges 
and initiatives that we need to take up.
    Mr. Westmoreland. OK. But, I mean, are you going to get any 
type of bonuses for doing better? Or if you don't do well, are 
they going to take any money away from you? I mean, is this 
just a package that you agreed with----
    Mr. Pedrotty. And just to clear up on any confusion on your 
part, I don't actually manage money on behalf of the union.
    Mr. Westmoreland. Oh, OK.
    Mr. Pedrotty. I'm, as my role here today, in more of a 
policy role and advising trustees who do manage our members' 
money.
    Mr. Westmoreland. OK. Do they get compensated?
    Mr. Pedrotty. Does who get compensated?
    Mr. Westmoreland. The trustees.
    Mr. Pedrotty. The trustees are not paid. I think their 
expenses are picked up, but they're not paid themselves for 
managing funds.
    Mr. Westmoreland. But the AFL-CIO, from reading your 
testimony, has had some success with Verizon. I think you made 
the point that they went to a stockholders meeting with 
Verizon, put together these votes and actually got Verizon to 
change their policy about the compensation. Is that not true?
    Mr. Pedrotty. That's right, both on the say on pay and 
compensation.
    Mr. Westmoreland. It says you also had success with General 
Electric, Home Depot and Sara Lee.
    Mr. Pedrotty. That's right.
    Mr. Westmoreland. So do you think the free market system 
works?
    Mr. Pedrotty. In relation to disclosure?
    Mr. Westmoreland. Yeah.
    Mr. Pedrotty. No, I don't think it works. I think a certain 
few companies are responding----
    Mr. Westmoreland. You all had some success with it, didn't 
you?
    Mr. Pedrotty. We had success. But, Mr. Westmoreland, a 
handful of companies doing right by their investors doesn't 
mean the free market's working.
    Mr. Westmoreland. But other investors in these companies 
could do the same thing and have the same success that you've 
had, right?
    Mr. Pedrotty. And they increasingly are. But they can't be 
able to vote in an informed fashion on CEO pay or know about 
the conflicts that exist if the information isn't there. A 
basic premise that I operate under is markets operate well 
under good information. We don't have good information, let 
alone the tools to hold people who act on that information 
accountable.
    Mr. Westmoreland. OK. Well, you know, we, on our march to 
socialism, you know, we just tend to interfere in business. You 
know, we started out at the bottom and working our way up with 
minimum wage, and now we're starting at the top, working our 
way down. It's going to be interesting what happens when we get 
to middle management and supervisors.
    But, you know, talking about pay for performance, I think 
if you looked at the 110th Congress, if we got paid for our 
performance, we'd be making about $1.98. So let's just thank 
God that we haven't gotten to----
    Mr. Pedrotty. What about the prior Congresses?
    Mr. Westmoreland [continuing]. Where we make sure 
everybody's getting paid for performance.
    But I yield back the balance of my time.
    Chairman Waxman. Do you yield back the balance of your time 
or the balance of your salary?
    Mr. Westmoreland. Well, either one is fine.
    Chairman Waxman. Mr. Murphy.
    Mr. Murphy. Thank you very much, Mr. Chairman.
    I want to welcome Ms. Miller here today. The Office of the 
Treasurer in the State of Connecticut has been for a very long 
time an outspoken advocate for the investor community in 
general and, as you can see by Ms. Miller's testimony here 
today, a leader in this Nation in looking out for investors' 
rights.
    And I wanted to just talk specifically about the issue of 
the SEC actions that took place about a year ago in terms of 
the new regulations and rules that were promulgated and how far 
we still have to go. We've talked a little bit about it here 
today, but obviously we've at least uncovered the fact that the 
SEC can do more, at the very least to require disclosure about 
what kind of other work these consultants are doing.
    I wanted to just to give you, Ms. Miller, the opportunity 
to talk a little bit more about the adequacy of the SEC 
regulations in the first year of promulgation and whether there 
are other avenues in addition to trying to look at what other 
work these consultants are doing for the company that we should 
be advocating for as we ask the SEC to pursue this issue 
further.
    Ms. Miller. Thank you very much for that question.
    As many of the people in this room know, this is the first 
year that the SEC had new disclosure rules, and they inserted a 
new portion called the Compensation Disclosure and Analysis 
[CD&A]. And both the public's analysis, investor analysis, 
consultants' analysis, and even the SEC's analysis of the 
performance of the reporting by companies in that first year 
determined that it was woefully inadequate. And so, the 
problems were that a lot of the compensation committees did not 
provide clear information.
    And so the SEC actually tried to deal with this issue by 
doing a targeted review, where it sent out over 300 letters to 
companies saying, ``You need to do better reporting on a number 
of issues.'' What was noticeably lacking in the staff's 
questioning of the companies was, again, this issue of 
disclosing whether compensation consultants were independent. 
And then even furthermore, once the staff sort of went through 
the first few hundred of the letters, they recently issued a 
document that's on the SEC Web site called ``Staff Observations 
on the Compensation Disclosure and Analysis.'' And, again, in 
there, on their observations, they do not guide companies to 
better disclose on the compensation consultant conflict.
    And so, there are so many opportunities here that we've had 
with the SEC to pay attention to this issue. They've ignored 
investor comments on this. The treasurer wrote a letter 
generally about it when they first proposed rules. She wrote 
another letter just focusing on the compensation consultant 
conflict. The Council of Institutional Investors and many more 
organizations commented from the investor point of view about 
the importance of this issue. And the SEC has continued to 
ignore it and decide that it's in the best interest for us that 
the compensation committees make a determination about what is 
independence.
    And I think when we just see this recent action by the SEC, 
I think it shows that there is tremendous need to bring to 
their attention the investor community's concerns and now the 
empirical data from the chairman's report.
    Mr. Murphy. Thank you.
    And just one other question to the whole panel. Other than 
potentially being a step toward our unending march toward 
socialism, would increased disclosure from the SEC on these 
particular points--do you see any downside? We've talked a lot 
about the upsides, but do you see any downside to asking the 
SEC to pursue disclosure at an increased level going forward?
    And I will just ask for everybody to comment very briefly 
on that.
    Mr. Elson. I can't imagine there would be a downside. 
You're not talking about, you know, vital corporate secrets 
that if you disclose will destroy the corporation. I think it's 
effective. Look, we disclose the auditors' conflicted 
transactions, and there's no damage done. I can't imagine any 
damage by disclosing the other forms of services that are 
offered. There are routine personnel issues that I don't think 
go to the heart of the strategy of the business, in my view.
    Ms. Miller. I don't think there's any downsides from the 
investor point of view. I do understand the impact that it may 
have on the industry, on the consulting industry, which they 
may view as a downside because of the organizational change. 
But I think that in the long run, in the long-term interest, 
this would be a good move for all parties interested.
    Mr. Shadab. I think a potential short-term downside is 
having companies disclose information which may not be material 
to the choice of whether or not to purchase or sell securities 
or to the value of securities. That's the short-term potential 
downside. And because investors only want information that is 
actually material to the price of the securities. Other 
information that's not relevant would just be confusing and 
flood the marketplace with information that's irrelevant.
    A second, more long-term potential downside is setting the 
precedent for further mandatory disclosures on the Federal 
level of information which is also not relevant to the choice 
to invest or not.
    Mr. Pedrotty. I think more information and better 
disclosure on conflicts is necessary and important, and I don't 
see any downside.
    What we are sensitive to is ensuring that companies, when 
they disclose their benchmarks and how they're paying and who 
they're comparing to, that not put competitive information out 
in the market. So we think retroactive disclosure in some 
cases, in terms of their peer group, is important.
    In terms of the march to socialism, I should just comment 
that I think we're to the right of some of our Republican 
friends, in that there's an interesting contrast: When it's the 
taxpayers money, there's outrage over how it's spent, but when 
it's the shareholders' money being given to an undeserving CEO, 
somehow that seems OK.
    So thank you, Congressman Murphy.
    Chairman Waxman. Thank you, Mr. Murphy.
    Ms. Foxx.
    Ms. Foxx. Thank you, Mr. Chairman.
    I really wonder why we are here today. There is a 
tremendous amount of work to be done in this Congress, which we 
are not doing. And to me, this has to be the most far afield 
hearing that I have seen since I have been in the Congress in 
the last 3 years.
    I spoke to the chairman recently and said, you know, I 
really got on this committee because I wanted to do something 
about the way the Federal Government operates. I want it to be 
more consumer-friendly. And I really want us to do our job. The 
title of this committee is Government Oversight and Reform. And 
here we are meddling in the private sector in a place we have 
absolutely no place being. This is not our responsibility.
    I think that it's an indication of how detached from the 
real world some of our friends are. They've been in Washington 
way too long. They have no idea how the private sector works. 
And I think it's really a sham. And I'm sorry that we are even 
doing this and wasting the time of these people and our time on 
it. I just find it unbelievable.
    But I want to point some things out. I think that if 
shareholders were upset about this issue, they'd be coming to 
us. I, frankly, have not gotten a single letter from any 
shareholder saying, ``This system isn't working. Why don't you 
fix this system?''
    And I find it very difficult to believe, Mr. Elson, that 
you say you believe in the market. Well, if you believe in the 
marketplace, then you wouldn't be trying to destroy business 
and industry in this country, as you are.
    We have more and more firms moving offshore in large part 
because of Sarbanes-Oxley and the rules that have been put in 
place. And we're going to see more of that. The more you try to 
restrict the marketplace, the more you try to make this a 
socialistic country, the more businesses are going to move. And 
I'm terribly distressed by this. We are the most successful 
country in the world, and it is in large part because of our 
capitalistic system.
    I want to ask Mr. Pedrotty--Pedrotty?
    Mr. Pedrotty. Pedrotty. You got it.
    Ms. Foxx. Thank you, Mr. Pedrotty. I want to ask you a 
couple of questions.
    The first one is, did you say, did I hear you say Wal-Mart 
is a pay-for-failure company?
    Mr. Pedrotty. That's right. Or pay-for-pulse, depending on 
your preference.
    Ms. Foxx. Or pay-for-what?
    Mr. Pedrotty. Or pay-for-pulse. Pulse.
    Ms. Foxx. OK. Undeniably one of the most successful 
companies this country's ever seen, you say it's pay-for-
failure.
    Mr. Pedrotty. And that's not us speaking, Congressman Foxx. 
That's an institution like the Corporate Library that puts out 
a pay-for-failure report that looks at the total shareholder 
return, the value delivered to institutional investors, 
including our funds. And they've characterized Wal-Mart as 
such.
    Ms. Foxx. OK. Well, let me ask you this. In your 
description of your job, it sounded like you do several 
different things, right? You said you advise the trustees. 
Could you name, like, the three or four major aspects of your 
position?
    Mr. Pedrotty. Sure. It's primarily advising our union 
pension funds and affiliates on corporate governance 
initiatives and strategies. Also doing a significant amount of 
work in front of the Securities and Exchange Commission on 
regulatory issues, everything from private equity to equal 
access to the proxy to CEO pay. So it's a fairly diverse policy 
platform.
    Ms. Foxx. Well, why shouldn't we demand, then, that the 
AFL-CIO restrict you to one aspect of your work? I mean, why 
should you be allowed to be working sort of two or three sides 
of an issue? I mean, if you want to stop the private industry 
from doing that, why shouldn't you be stopped from doing that?
    Mr. Pedrotty. I don't think we want to stop private 
industry from doing that. I think we want the advice they 
provide to our representatives of the board to be free from 
conflict. If there's some suggestion that, you know, I'm 
conflicted in any way, I would be interested in hearing that. 
But I think that's the basis on which our recommendation 
emerges.
    And, Congresswoman, it's also the basis for why companies 
themselves are following this system. If this was so egregious 
and burdensome, why are right-wing outfits like the Business 
Roundtable and the National Association of Corporate Directors 
making these recommendations?
    Ms. Foxx. OK. Another question is, don't you see a conflict 
of interest in your role in negotiating labor contracts with 
companies and also investing in those companies? Isn't that a 
conflict of interest and much worse than what you are 
describing for these consulting companies?
    Mr. Pedrotty. Congresswoman, we don't see any conflict at 
all. In fact, our goal is the same. Our goal is to both own and 
negotiate with companies that are creating long-term value, 
that can both provide substantial returns to our pension funds 
and employ our members. So those goals are the same.
    Chairman Waxman. Thank you, Ms. Foxx.
    Mr. Welch.
    Mr. Welch. Thank you, Mr. Chairman.
    As I understand it, the reason for our hearing is to see 
whether there are some policies that could wisely be promoted 
in order to protect shareholders and preserve corporate 
accountability. And we obviously have a debate about whether 
that's a valid purpose, but my view is that it is.
    Mr. Elson, one of the questions I have, the point's been 
made about the importance of having independence in 
compensation consultants. In materials we've seen, oftentimes 
the consultants get $1 in payment for compensation advice and 
they have $11 in services for other contracts, and they're 
being hired for those other contracts by the executives whose 
pay for performance they're reviewing.
    Is it your view that for many of these firms that do 
multiple services, that executive compensation is, in effect, a 
loss leader?
    Mr. Elson. Yes, I believe so. Executive comp is, frankly, a 
way into the executive suite, if you will, to access, you know, 
high-level folks at the company. So that as the other work 
would come in, I would assume--I mean, not having been a comp 
consultant, I would assume that the large amount of money that 
they make is not related to compensation consultants but the 
other services that they're in. And compensation, particularly 
when go in at the CEO level, puts you in a place, a very high 
point of visibility, a high point of contact within the 
organization that enables you to make those contacts to make 
the other businesses happy. I wouldn't suppose real money has 
been made. It's probably not on consulting but certainly on the 
other services. In fact, if you look at the income of these 
companies, the bulk of their revenue is coming from the other 
part.
    Look, I'm not attacking comp consultants. I think they 
provide a very valuable function to the comp community. I think 
they're actually quite helpful, in many circumstances. I think 
you just have to tweak a little bit how their advice is being 
given or the parameters under which their advice has been given 
to a committee.
    Mr. Welch. The loss is generally, whether it's Wal-Mart or 
executive compensation firms, that you offer a good price for 
providing other services. And my understanding, if I'm 
listening to your testimony correctly, is that for some of 
these firms, the opportunity to provide the compensation 
service gives them access to the management people who then 
make the hiring decisions on the other $11.
    Mr. Elson. Well, that explains why a lot of consultants--
the trend has now been to using independent consultants--have 
peeled off of the large firms and went and set up their own 
boutiques. The nice thing about getting a boutique player today 
is that most of them are graduates of these large firms. And 
the firms themselves chose to keep the other work.
    Mr. Welch. Thank you.
    Ms. Miller, I want to ask you a question. There's been some 
back and forth here about whether the labor organization has 
some agenda that interferes with capital.
    Your responsibility is to the pension holders, which are 
workers and others in the State of Connecticut. Correct?
    Ms. Miller. Yes.
    Mr. Welch. So your bottom line is to have the maximum 
return to your pension holders and the minimum cost to your 
taxpayers. Is that correct?
    Ms. Miller. Yes.
    Mr. Welch. So do you have any--just explain to me briefly 
what the policy basis is for your view about executive 
compensation needing some rules or regulations that will 
protect the interest of the people that you represent as the 
deputy treasurer.
    Ms. Miller. Sure. Thank you.
    My testimony includes some empirical data from the 
Corporate Library that Dan also referred to that shows the 
losses that shareholders incur when executives are paid 
excessively while at the same time companies are performing 
poorly. And the losses over time accumulate to be significant 
amounts, which obviously impact a pension fund such as the 
State of Connecticut's.
    Even more recently, we saw the losses due to the subprime 
mortgage problem that many companies have incurred while their 
exiting CEOs were paid handsomely and, in some cases, you know, 
total packages that were astounding.
    So I think that our goal--the treasurer is the sole 
fiduciary, principal fiduciary of the Connecticut $26 billion 
pension fund. And in that regard, she moves on these issues, 
which is really your question, because she has a fiduciary 
responsibility not only to vote her proxies and to monitor them 
but to engage in corporate governance activities, whether it be 
directly with companies or on a policy level that can enhance 
the value of our investments.
    Mr. Welch. Thank you.
    You know, my friend Congresswoman Foxx said that she hasn't 
heard much from shareholders, and I have to say I haven't heard 
from shareholders either. Yet you've indicated that on behalf 
of your pension holders, you have been an advocate for some 
reform.
    What impediments have you run into when you've made efforts 
to try to get greater oversight and independence on this 
executive compensation?
    Ms. Miller. Well, the SEC has totally ignored investor 
comments. There's a public record of comments submitted when 
the SEC proposed rules, where investor coalitions, the Council 
of Institutional Investors, which is the largest consortium of 
public funds and private funds, weighed in on this issue as 
well. And so the impediment is that we cannot seem to get the 
attention of the SEC throughout any of its work in this area or 
any of its oversight on the quality of the reporting of 
companies on compensation.
    Chairman Waxman. Thank you, Mr. Welch.
    Mr. Welch. Thank you, Mr. Chairman.
    Chairman Waxman. Mr. Souder.
    Mr. Souder. Thank you, Mr. Chairman.
    I was watching earlier in my office because we can have 
wall-to-wall committees on in our committee C-SPANs.
    Mr. Elson, I thought I heard you say you serve on several 
boards?
    Mr. Elson. Yes, sir.
    Mr. Souder. Could you name them?
    Mr. Elson. Currently on the board of HealthSouth Corp. and 
AutoZone Corp.
    Mr. Souder. How much do you get compensated on those 
boards?
    Mr. Elson. I think the AutoZone, I think it's $3,000 stock 
options a year and I think $40,000-some in cash that can be 
taken in company stock.
    Mr. Souder. Have you exercised any of those stock options?
    Mr. Elson. No, sir.
    Mr. Souder. On the HealthSouth, what did you say your----
    Mr. Elson. I think it's about--we have a half-stock, half-
cash retainer system--about, oh, $100,000 in cash which may be 
converted to company stock and then another, oh, I'd say about 
$80,000, $90,000 in restricted stock.
    Mr. Souder. Did I understand you to say that you felt board 
members were idiots?
    Mr. Elson. No, sir. I think a board member who would ignore 
the demand of a shareholder or shareholders and knowingly 
willingly hire a conflicted consultant in the face of a serious 
investor opposition and with the changed legal environment, it 
would be acting problematically for them, from their own 
standpoint.
    Mr. Souder. So you think that any company such as Verizon, 
until they got under--that the reason companies are switching 
is because they're being smeared. It isn't because of a 
stockholder opposition. It's because you and others are 
smearing them in the general public, and it becomes difficult.
    Now, the question is, you in effect just said that every 
board in the country that hires one of these consultants aren't 
acting in the interest of their shareholders, that they're more 
or less idiots, and smeared them, when you yourself sit on 
different boards, earn an incredible amount of money, have 
potentially multiple different conflicts in what you are saying 
here and how what you say here influences. The answer of the 
representative from the AFL-CIO was laughable.
    You do have a conflict of interest. That's what businesses 
deal with on a daily basis. When I went to undergrad and grad 
school and went through case work, trust departments and banks 
have inherent conflicts of interest because people who are on 
their boards sit on companies that the presidents of the banks 
and the vice presidents sit on companies, then they make 
investment decisions. Every day they have to decide which stock 
do they dump first based on information, who do they know. You 
have conflicts of interests in country clubs. You have 
conflicts of interest in how you do cost accounting.
    Government can't fix every ethical lapse. We try to have 
clarity. These things try to get supported. But you have come 
here today and smeared multiple companies.
    And, Mr. Chairman, in your opening statement I heard you 
say that you didn't have any evidence that--what you said was, 
you said what we have in front of us is compensation going up 
and executive consultants being involved in this process who, 
in your opinion, have conflicts of interest, not understanding 
apparently divisions in companies and rules that exist in the 
division of companies. And though you didn't have any evidence, 
you said the evidence was compensation is going up and 
consultants exist. That's not evidence. That's what you said in 
your opening statement. That's what this so-called Democratic 
report states.
    There's no facts. We've had one person here talk about 
economics today and three witnesses talk about politics. And 
you can go back to George Mason and talk to other economic 
people and capitalists, and this is why they mock Congress. We 
have a hearing that's supposed to be about economics. And 
instead it of economics, you are the only one who talked about 
how the markets actually work. Everything else has been 
political today, about opinions.
    Do you think the AFL-CIO has a conflict up here today 
talking about Wal-Mart when you picket them all over the 
country, when you attack them? Look, companies can or can't 
unionize. But you have a conflict of interest in smearing Wal-
Mart. You quoted some organization that I don't know, may have 
reflected one annual survey where they did, you know--and then 
put your editorial comment, implying that organization said 
that Wal-Mart has either basically dead people or reward false, 
you know, reverse compensation. Now, nobody in this country 
believes that Wal-Mart would be the best--the fastest-growing 
company in the United States or in the world if, in fact, their 
management was, as you stated, quoting your interpretation of 1 
year's probable report of a company we don't know about that 
claims that they reward deadweight. If they rewarded 
deadweight, Wal-Mart would disappear. There is a market that's 
holding Wal-Mart accountable, not you.
    And I find, quite frankly, this hearing one of the most 
appalling, embarrassing hearings I've ever had--that we've had 
in this committee. Instead of oversight like we did under the 
past, Mr. Chairman, we are having repeated hearings where we 
release some dramatic statement, then no facts come at the 
hearing. The committee is embarrassed. Anybody who watches the 
details of the hearing--the hearings themselves don't match the 
allegations. And it's been an embarrassing process. As a senior 
Member of this House who has been through under four or five 
chairmen, this is just embarrassing. I'm just sorry.
    Chairman Waxman. The gentleman's time has expired, but Mr. 
Elson ought to have an opportunity, I think, to respond to the 
statements made.
    Mr. Davis of Virginia. Mr. Chairman, can I just make one 
comment on George Mason University? Not only is it economics, 
but we've produced two Nobel Prize winners out of our Economics 
Department at George Mason University.
    Chairman Waxman. Mr. Elson, do you want to respond to the 
personal attacks on you?
    The attacks on me I'll just ignore.
    Mr. Elson. Well, I think that, first of all, those 
companies that made the changes, I think they did it because it 
was the right thing to do. And I think they recognized that if 
you don't protect the investors, then the capital that is 
fundamental to our free market system disappears. If you don't 
respect the----
    Mr. Souder. Mr. Chairman, he is not defending my attack on 
him. He is continuing to talk like he's been talking----
    Chairman Waxman. Mr. Souder, you can't evidently accept the 
fact that anybody disagrees with you. You made a statement 
about him, and do you think he should not have a chance to 
respond?
    Mr. Souder. He is not responding about himself. He's just 
giving----
    Chairman Waxman. You don't like his response, but do you 
think he ought to have a chance to respond?
    Mr. Souder. No, I didn't attack him personally any more 
than he attacked all the other people.
    Chairman Waxman. You attacked him as saying he's smearing 
capitalism, he should go back to his university and whatever 
else you had to say.
    Do you feel you have anything else to say, Mr. Elson, 
because we do have to----
    Mr. Elson. I am a free-market capitalist and happy to be 
so.
    Chairman Waxman. You are. Thank you.
    We'll now turn to Mr. Cummings.
    Mr. Cummings. Thank you very much, Mr. Chairman.
    In light of what Mr. Souder just said, I want to remind all 
of us that it was the Conference Board, the National 
Association of Corporate Directors, the Business Roundtable and 
the New York Stock Exchange that expressed concerns about 
conflicts and wanting those conflicts to be revealed. And I 
don't know that those are but so much political folk, I don't 
know, but the fact is that they are reputable and they 
expressed concerns.
    Experts and some of our panelists today note that the 
consultant conflict we are discussing is analogous to the 
conflict faced by audit firms prior to passage of the Sarbanes-
Oxley reforms. One of the lessons of Enron was that when 
auditors have multiple business relationships with a company, 
their independence is questionable. Arthur Andersen, which was 
one of the most distinguished audit firms in the Nation, signed 
off on Enron's books. An independent auditor should not have 
done this. But in Arthur Andersen's case, it was being richly 
paid by Enron to provide a range of consulting services.
    To prevent these kinds of abuses, the Sarbanes-Oxley law 
said that auditors have to be independent. Compensation 
consultants appear to have similar conflicts. Like auditors 
that were motivated to cross-sell more lucrative nonaudit 
services, compensation consultants are selling more lucrative 
services beyond executive compensation, and this is where the 
real money is. As the committee report shows, the fees for 
these other services far exceed those earned for pay advice.
    Professor Elson, is the conflict that we see with 
compensation consultants similar to the auditor conflicts that 
were pervasive before Sarbanes-Oxley?
    Mr. Elson. It is extremely similar. And that's why I think 
Congress's response on the auditor conflicts on Sarbanes-Oxley 
makes perfect sense on disclosure of the conflicts that we have 
in this situation. It's almost identical.
    Mr. Cummings. Mr. Pedrotty and Ms. Miller, what is your 
view on this? And have regulators and investors been able to 
resolve similar situations involving conflicts in the past?
    Mr. Pedrotty. Congressman, we have. And that's why we think 
Verizon's a good example. Verizon responded not to a smear 
campaign but to the vote of a majority of investors, including 
large mutual funds and recommendations like you cited--NACD, 
NYSE and Business Roundtable--and agreed to ban work for both 
advising the committee and also advising the company.
    But that's why we got here, Congressman. The consultant at 
Verizon had done a half-a-billion dollars' worth of business 
for the company at the same time they were advising the board. 
That's why we think, despite the performance suffering, the 
CEO's pay went up.
    So we think it's sort of a good-news/bad-news tale, that 
companies are responding now, they're following best practices, 
but we have much farther to go. And that includes going beyond 
just naming the consultant, as required by the SEC right now. 
We need, A, better disclosure so we can take these conflicts 
into account, but, B, we should have the tools to hold them 
accountable, just like we can vote increasingly on the CEO's 
pay and just like we can vote on the auditor. So that's why 
that analogy is pertinent.
    Mr. Cummings. Ms. Miller.
    Ms. Miller. Yes, thank you, Congressman.
    The study that Treasurer Nappier led, where we approached 
the 25 top U.S. companies, resulted in showing that 12 of those 
compensation committees did pass formal policies in the recent 
disclosure addressing the issue of compensation consultant 
independence. This confirms and underscores Dan's remarks that 
a lot of the companies, when brought to their attention, are 
willing. And the letters that they wrote back to the treasurer 
affirmed that they are in agreement with us, these compensation 
committees, that indeed there is a potential conflict of 
interest, whether it be actual or just perceived, that it's 
important that they address it. And we are very much aligned in 
that. Eleven of the 25 companies have an outright ban on the 
use of compensation consultants who work for management of the 
same company.
    I just wanted to address your point about the auditor and 
whether this hearkened back----
    Mr. Cummings. And while you are answering that, would you 
let me know whether you think that Congress should be 
considering legislation to eliminate this conflict, like we did 
with Sarbanes-Oxley?
    Ms. Miller. Thank you.
    I think that we should first take the step to urge the SEC 
to revisit this issue and to require disclosure by the 
compensation committees about the potential conflicts. And then 
we should take a hard look at that, and if the best practice 
hasn't spread rapidly throughout corporate America, we should 
seriously consider legislation that would prohibit the use of 
conflicted consultants.
    I just wanted to mention that, prior to the passage of 
Sarbanes-Oxley, the SEC ignored investor comments to have a 
strong ban against auditor consulting work. They passed a rule. 
And after that rule was when Enron and the other companies' 
corporate scandals occurred. And that is what caused the 
passage of--in part, the passage of Sarbanes-Oxley.
    We're exactly on the same path here with the SEC, where 
they are ignoring investor comments and concerns about this 
issue. And should they pass something, we would hope that it 
would be strong enough not to have to lead to legislation, like 
we ended up with Sarbanes-Oxley.
    Chairman Waxman. Thank you, Mr. Cummings.
    To conclude the questioning of this panel, I wanted to 
recognize Mr. McHenry.
    Mr. McHenry. I thank the chairman.
    Mr. Shadab, this is directed to you. I'm on the Financial 
Services Committee. We've had a lot of discussion about the 
cost of Sarbanes-Oxley, the raw cost. And that is directly 
passed on to the investors, and the cost of separating 
consultants and auditing and everything else.
    Now, it seems to me that others on this panel from the 
majority's witnesses contend that this is, you know, very good; 
we should sort of expand Sarbanes-Oxley to consultants of all 
sorts; that you only can consult on one issue area and that's 
it.
    So can you talk about--let's talk about the cost to this. 
Because we've done a number of hearings on the Financial 
Services Committee and on this committee in the last Congress 
on the cost of Sarbanes-Oxley. So if you could touch on that.
    Mr. Shadab. Sure. Several studies have shown very high 
compliance costs with Sarbanes-Oxley. And those are pretty 
well-known. There are other studies and there are some 
conflicting reports out there about the cost to American 
competitiveness or the capital markets, the extent to which 
companies are either going private, staying private or going 
public elsewhere in response to not only just Sarbanes-Oxley 
but other regulatory issues that are unique to the American 
legal structure, such as plaintiff lawsuits and other forms of 
regulatory burdens unique to American companies.
    In addition, several studies, such as one of my own, has 
shown that Sarbanes-Oxley seems to have reduced the risk-taking 
activity by public companies and reduced their incentives and 
ability to undergo innovation activities and create more new 
products and services for consumers than they otherwise would 
have.
    So those are some of the costs of Sarbanes-Oxley.
    Now, specifically with respect to the issue of nonaudit 
services and auditors, Sarbanes-Oxley is a really poor example 
of legislation that was based upon actual--the benefiting the 
investors based upon economic evidence with respect to whether 
or not there is an actual conflict of interest when auditors 
provide nonaudit services. In fact, that aspect of Sarbanes-
Oxley and many others were really rushed through Congress not 
based on empirical evidence but, actually, to the contrary, 
most of the empirical data that shows any impact on investors 
when auditors provide nonaudit services, consulting services 
for example, shows that it actually improves audit quality.
    So we shouldn't sit here and I urge the committee not to 
draw the wrong lesson from Sarbanes-Oxley, especially with 
respect to the issue of auditors and conflicts of interest and 
try to analogize to compensation consultants on their potential 
conflicts of interest. Certainly, there are potential conflicts 
of interest throughout the business community, but potential 
conflicts of interest are not actual conflicts of interest. And 
we shouldn't assume them to be so, especially when we at least 
perceive to be tradeoffs and benefits from providing 
noncompensation consulting services.
    Thank you.
    Mr. McHenry. Thank you. I appreciate you touching on that.
    Now, Mr. Pedrotty from the AFL-CIO, now, looking at your 
testimony, it says, ``Today's compensation consultants perform 
lucrative consulting work unrelated to the investor protection 
role they're supposed to play.'' Now, so, with that, the 
consultant has a fiduciary responsibility to the investor; is 
that your contention?
    Mr. Pedrotty. We think that when a consultant is at the 
same time advising the board on how to strike the best arm's 
length deal but also doing a significant amount of business for 
the company itself, in some cases hired by the person whose pay 
they're weighing in on, that presents a concern for us. And at 
the very least, we need better information. It's much like----
    Mr. McHenry. All right. But let me ask this. Does a 
consultant have a fiduciary responsibility to the investor?
    Mr. Pedrotty. No, but they should.
    Mr. McHenry. OK. No, but they should. Under your testimony, 
you said ``unrelated to the investor protection role they are 
supposed to play.'' It's the board that has the fiduciary 
responsibility.
    Mr. Pedrotty. Fiduciary. Right.
    Mr. McHenry. Thank you for correcting me. I've got a cold, 
so I'm having a hard time getting words out.
    Not the consultants. It is the board that makes the 
decision. Is that correct?
    Mr. Pedrotty. It is. But we see----
    Mr. McHenry. The condition is that everyone who does any 
consulting work for any company has to have fiduciary 
responsibility?
    Mr. Pedrotty. No. I think the problem at the very 
beginning, though, is the board is relying on advice that may 
be conflicted. Investors should know about that conflict, and 
they don't. And we even have boards making almost an admission 
of failure. Two-thirds of boards are saying that, you know, CEO 
pay is out of control; they're having trouble controlling it.
    Mr. McHenry. That's a different issue. What you are trying 
to do is actually take consultants who provide market 
information--which is what the AFL-CIO does to a good extent, 
as well. You provide market information on pay and you want to 
raise people's pay, but you actually want to lower executives' 
pay, which is an interesting conflict.
    Mr. Pedrotty. That's not what we're saying. We're not 
saying that----
    Mr. McHenry. Let me finish here, sir.
    Chairman Waxman. Well, the gentleman's time has expired.
    Mr. McHenry. If I may finish this thought, Mr. Chairman.
    Chairman Waxman. OK.
    Mr. McHenry. You know, the interesting thing here is your 
contention is, if you are a consultant advising the board, yet 
your contention is they may have a conflict of interest because 
they have another part of their business that does work for the 
company. So your contention is that maybe they're charging a 
much higher rate than they should, thereby deriving--that's 
what a conflict is really about. So if they have another line 
of business that is charging this company extra money, thereby 
pocketing money for the consultants, that the board's too dumb 
to actually realize it.
    And that's something that I just think is flat wrong. It's 
a failure to understand the fiduciary responsibility of the 
board and let them make the best judgment call, not have 
Congress dictate to them what they shall and shall not do.
    Mr. Pedrotty. We want consultants to drive the best bargain 
we can in negotiating with CEOs. The board drives that bargain. 
They rely on advice from consultants.
    If the consultant knows that enormous amount of business, a 
multiple of what they're earning for advising the board is with 
the company itself, if the consultant knows that the CEO has 
hired them, are they want to alienate that person and not be in 
a position to be hired----
    Chairman Waxman. The gentleman's time----
    Mr. McHenry. Mr. Chairman, this is really about executive 
compensation and not about consultants. So I think it's a valid 
hearing to have about executive compensation. But the 
consultants are simply providing information. It's the boards 
that are really making the decisions.
    So with that, I will be happy to yield back.
    Chairman Waxman. You have no time to yield back. But the 
gentleman's time has expired. I want to thank you for your 
comments.
    I want to thank this panel for your presentation and 
answering the questions of the Members.
    We are going to have to recess to respond to votes on the 
House floor. So we will return and start with the next panel at 
12:20. Thank you very much.
    [Recess.]
    Chairman Waxman. I would like to reconvene the hearing.
    For our second panel I would like to welcome Donald Lowman, 
the managing director of Towers Perrin Executive Compensation 
and People Advisory consulting services; Charlie Scott, 
president of Mercer's human capital consulting business, which 
handles executive compensation matters for the company. Michael 
Powers is the global practice leader for executive compensation 
and corporate governance for Hewitt Associates. George Paulin 
is the chairman and chief executive officer of Frederick W. 
Cook & Co. James Reda is the managing director and founder of 
the James F. Reda & Associates, an executive compensation 
consulting firm.
    We're pleased to have you with us today. Your prepared 
statements will be in the record in their entirety.
    Before I ask you to make an oral presentation, it is the 
practice of this committee that all witnesses that testify 
before us do so under oath. So I would like to ask you if you 
would stand and raise your right hands.
    [Witnesses sworn.]
    Chairman Waxman. The record will indicate that all of the 
witnesses answered in the affirmative.
    I mentioned all your prepared statements will be in the 
record in full. We'd like to ask, if you would, to try to limit 
the presentation to around 5 minutes. We'll have the clock 
there. It will be green, and then it will turn yellow, 
indicating 1 minute left, and then red, indicating the 5 
minutes have expired.
    Mr. Lowman, why don't we start with you? There's a button 
on the base of the mic. Be sure to press it.

STATEMENTS OF DONALD LOWMAN, MANAGING DIRECTOR, TOWERS PERRIN; 
 CHARLIE SCOTT, PRESIDENT OF HUMAN CAPITAL CONSULTING, MERCER; 
     MICHAEL POWERS, GLOBAL PRACTICE LEADER FOR EXECUTIVE 
   COMPENSATION AND CORPORATE GOVERNANCE, HEWITT ASSOCIATES; 
 GEORGE PAULIN, CHAIRMAN AND CEO, FREDERICK W. COOK & CO.; AND 
   JAMES REDA, MANAGING DIRECTOR, JAMES F. REDA & ASSOCIATES

                   STATEMENT OF DONALD LOWMAN

    Mr. Lowman. Thank you, Chairman Waxman. Good afternoon to 
all the committee members, and thank you for inviting Towers 
Perrin to participate today in this discussion.
    My name is Don Lowman. I am managing director of Towers 
Perrin and also a member of our board of directors. I've been 
with the firm 25 years, have held various leadership positions 
in addition to my consulting experience. And I hope my comments 
today will address many of the issues that are of greatest 
importance to the committee.
    First, a few words about Towers Perrin's executive 
compensation consulting practice. We certainly recognize, as 
many others have commented, that there's a perception of and 
also the potential for conflict of interest in compensation 
consulting, indeed in all consulting. Our executive 
compensation practice, which is delivered by a separately 
identified line of business, is built around strong and 
effective processes and protocols which preclude conflict 
issues and which allow us to achieve our goal of providing 
input, sound and objective advice to our clients.
    And among these protocols are the following. First, we 
perceive that our client is always the company. We are not 
agents for the CEO. We don't consult to, nor advocate for, any 
individuals. And, indeed, we're not paid by the CEO. Second, 
our fees are unrelated to any level of executive pay. Our fees 
are not a function of the size of any given executive's 
compensation package. Third, our consultants receive no direct 
reward for promoting or selling other services provided by our 
firm. Fourth, our code of business conduct, which has been in 
place for nearly 15 years, clearly articulates the firm's 
commitment to providing clients with services that are 
impartial and objective. Last, we have operating procedures, 
such as independent peer review. We wall off individuals who 
serve as board-appointed consultants from other client-related 
work.
    This committee has expressed a concern about a firm 
providing both executive compensation consulting services and 
other consulting services to the same company. We don't believe 
a firm's ability to deliver sound, objective and conflict-free 
advice is compromised simply because other people in the same 
firm may also provide other consulting services to the client. 
Precluding executive pay consultants from other company 
engagements will not resolve what I believe this committee's 
fundamental concern with CEO pay is and the so-called wage gap. 
In fact, there's evidence that where executive pay consultants 
do no other work for a company, the result has often been the 
highest levels of executive pay. I will refer to the Corporate 
Library report later on during the question period.
    I would like to talk a little bit about what we see as some 
of the possibilities for improving the processes around setting 
executive compensation. As the committee considers this issue, 
it's important to keep in mind that a company's compensation 
committee and board are vested with responsibility for pay 
decisions. There are, indeed, egregious examples in the areas 
of corporate governance and executive pay that don't represent 
the overwhelming majority of companies and boards nor the 
professionals who advise them.
    Moreover, we have seen significant changes and reforms 
which have been implemented to enhance transparency, strengthen 
corporate boards and increase shareholder rights, among them 
improvements in governance resulting from Sarbanes-Oxley; 
shareholder activism coupled with new proxy disclosure 
requirements; stock option expensing requirements; directors 
who have become smarter, more committed, better prepared and, 
for the most part, unafraid to ask tough questions; 
compensation committees that focus on what's right for their 
company today; and the challenging of outmoded elements of 
historical conventional wisdom.
    All of what I just talked about is good, and it should be 
given a chance to work. Corporate America has never been more 
conscious of executive pay and the implications for not getting 
it right. Indeed, I would just submit to this committee that 
the fact that you've asked for this information, that it's been 
provided to you, has actually raised the awareness of this 
issue in corporate board rooms and compensation committees 
around the country. We've been asked to testify to and reaffirm 
our independence, and we've done that in all cases. And in a 
majority of cases, there has been no change.
    While no ready-made formula exists to satisfy all 
interested parties, certain enduring principles are receiving 
increased emphasis in board rooms across the country. These 
include good governance. It all starts with good governance. In 
today's environment, duty of loyalty and duty of care define 
the commitment and responsibility the board members have to the 
shareholders they serve.
    More committed and courageous board members make a 
difference. These days, compensation committees are taking an 
increasingly active role. Polite and predictable give-and-take 
has given way to far more searching analysis and negotiation. 
Testing scenarios help ensure sound design. The relatively 
recent use of what we call tally sheets helps ensure that 
virtually all scenarios are explicitly contemplated by the 
compensation committee. We believe that survey data should be 
used judiciously with a host of other information to inform, 
but not determine, how much a particular executive should be 
paid.
    Talent management and succession planning make for more 
affordable pay. Increased emphasis on thoughtful talent 
management and succession planning can reduce the need to buy 
expensive outside talent.
    Towers Perrin clearly recognizes the critical importance of 
the role we play in ensuring good corporate governance. We take 
this role very seriously. And, again, I want to thank you, Mr. 
Chairman, for inviting us to be with your panel today.
    [The prepared statement of Mr. Lohman follows:]

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    Chairman Waxman. Thank you very much, Mr. Lowman.
    Mr. Scott.

                   STATEMENT OF CHARLIE SCOTT

    Mr. Scott. Mr. Chairman, Ranking Member Davis and members 
of the committee, my name is Charlie Scott, and I am president 
of Mercer's Human Capital Consulting business.
    We welcome this opportunity to describe for you the nature 
of our working relationship with executive compensation 
clients, our consulting framework for promoting responsible 
executive pay, and the steps we take to give our clients 
objective, unbiased advice and help them discharge their 
responsibilities.
    Mercer's executive compensation consultants help 
compensation committees in two primary ways. First, our 
consultants help the committee establish a philosophy regarding 
executive pay that provides the backdrop for specific programs. 
Second, they provide a context of objective and expert 
analyses, advice and information to assist the committee in its 
decisionmaking role.
    Mercer and its affiliates also provide a wide variety of 
products and services in the consulting, outsourcing and 
investments arenas to clients, their benefit plans and to 
employees.
    Mercer's aware that some have raised concerns that 
providing executive compensation services as part of a 
diversified business model could present a potential conflict 
of interest. The critical issue, which your committee has 
identified, is whether potential conflicts of interest are 
prudently and effectively managed and disclosed. Mercer has 
recognized this and other potential stresses on executive 
compensation decisionmaking and elected to take market-leading 
position on the need for a more reasonable approach to the 
process.
    In 2005 Mercer developed and implemented our Global 
Business Standards. These standards are the central governing 
document for our executive compensation consulting business. 
These standards are provided to all of our clients. They 
enhance transparency, establish a framework for the effective 
management of these issues, and allow Mercer consultants to 
provide high-quality, unbiased advice.
    Mercer's Global Business Standards address three areas: 
first, managing the consulting relationship; second, ensuring 
the quality of consulting services; and third, structuring our 
business to manage potential conflicts of interest.
    Let me first discuss how we manage the consulting 
relationship. A clearly defined client relationship provides 
the foundation for ensuring the objectivity and integrity of 
our advice. This begins with an engagement letter that 
documents the key elements of the assignment and relationship. 
It sets forth responsibilities, scopist services, fees, 
timeframe and client reporting relationships, including how and 
to whom information and recommendations are communicated. 
Engagement letters with a compensation committee include 
disclosure of any other financial relationships Mercer has with 
a company.
    Now let me talk about the second element of our Global 
Business Standards, which is ensuring the quality of our 
advice. Executive compensation consulting services are 
performed only under the direction of a human capital business 
principal. These individuals are Mercer's most senior 
consultants. Mercer's professional standards require that all 
consulting advice be peer-reviewed before it is rendered.
    Mercer has also developed a framework for working with 
clients in four critical areas: remuneration, performance, 
regulations and governance. This framework helps clients avoid 
focusing on pay competitiveness at the expense of performance 
against peers and prudent governance of the programs.
    Let me turn to the final element of our Global Business 
Standards, how we structure our business. Our executive 
compensation consultants are not paid based upon client revenue 
from other Mercer lines of business. Furthermore, our client 
relationship managers and other sales-focused employees do not 
evaluate performance or determine compensation for executive 
compensation consultants. This is done only through our human 
capital leaders.
    Our Global Business Standards also require our consultants 
to seek advice from the human capital business leadership if 
there's ever any question that our objectivity or integrity is 
at risk of being comprised.
    Consultants have the authority to discontinue relationships 
in cases where potential conflicts cannot be resolved.
    Finally, Mr. Chairman, for clients that need the depth and 
breadth of resources that Mercer can provide but also want an 
additional review, we suggest an independent oversight model. 
Under that model, clients retain a separate outside advisor to 
provide oversight and review of our recommendations. This 
advisor would have no other relationship with the company. We 
believe that these elements provide a best-practices approach 
to our work.
    Thank you.
    [The prepared statement of Mr. Scott follows:]

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    Chairman Waxman. Thank you very much, Mr. Scott.
    Mr. Powers.

                  STATEMENT OF MICHAEL POWERS

    Mr. Powers. Good afternoon, Chairman Waxman and members of 
the committee. I'm Michael Powers. I am our global practice 
leader at Hewitt for executive compensation and corporate 
governance consulting. Thank you for the opportunity to appear 
before you today.
    I will be discussing our role in the executive compensation 
decisionmaking process, as well as the policies and safeguards 
we follow to ensure that we provide objective and unbiased 
counsel.
    Hewitt takes very seriously its obligation to provide 
sound, informed, independent advice. Companies and boards of 
directors engage our services because of our strong and 
longstanding reputation for both quality and objectivity.
    It is important to note that our role in determining 
executive compensation is strictly as an advisor. It is up to 
each company's compensation committee, as part of their 
fiduciary responsibility to shareholders, to decide on the 
process it will follow, the input it will consider and, 
ultimately, the final design and amount of executive 
compensation arrangements.
    Compensation committees have a complex task in managing 
executive pay decisions. They often review a wide variety of 
information. This might include data on both what and how other 
peer organizations pay, the company's recent or long-term 
financial performance, the returns generated for shareholders, 
the company's perspective leadership needs and the demand for 
talent in that industry. They may also rely on input from 
senior management, legal counsel, executive recruiters or other 
consultants.
    By working with a multi-service consulting firm, Hewitt's 
comp committee clients have access to perhaps the broadest 
array of global resources, comprehensive market data, and 
design and technical experts. The information and advice Hewitt 
provides are just one of many sources that a board's comp 
committee may draw on to meet its fiduciary obligation to make 
appropriate pay decisions.
    Hewitt employs a number of practices and procedures to 
ensure the independence of our executive compensation services. 
These safeguards have evolved over time, and we certainly adopt 
new ones in an ongoing process of establishing and improving 
best practices.
    Hewitt's executive compensation consulting services are a 
separate business unit. As part of that structure, our 
executive pay consultants are paid solely based on the results 
of that unit and their own individual performance.
    Our additional safeguards are also recognized as best 
practices. These would include establishing distinct engagement 
agreements directly with our comp committee clients that detail 
our role and responsibilities as the committee advisor; 
proactively providing summary disclosures to our comp committee 
clients detailing all Hewitt services provided to the company; 
adhering strictly to internal and external confidentiality 
requirements regarding all client information; strictly 
following Hewitt's code of conduct and professional standards 
prohibiting public disclosure and discussion of client-specific 
information; enforcing a policy prohibiting a Hewitt employee 
from directly investing in the client organizations they serve; 
and establishing separate overall account management by 
professionals who are not involved in executive compensation 
consulting.
    In our experience, most compensation committees have both 
thoroughly and regularly reviewed perceived and potential 
conflicts-of-interest issues and have arrived at informed 
conclusions tailored to their unique situations. In some cases, 
boards have chosen to require exclusive relationships with 
their executive compensation consultants. Other boards have 
taken different approaches to ensure they are receiving high-
quality, independent advice, including evaluating the advice 
given, monitoring fees paid, restricting the provision of 
additional services, and the use of the two-consultant model.
    To conclude, we provide information and perspectives to 
help our clients design effective executive pay programs. Our 
approach enables our clients to make decisions based on the 
best available data and advice.
    But at the end of the day, we believe executive pay levels 
are driven primarily by global market forces. The competition 
for the talent pool of qualified men and women who are capable 
of effectively leading and managing complex organizations has 
intensified. Increasingly, companies are bidding for the 
services of this same cadre of talented executives, a trend 
which is expected to continue.
    Our role as compensation consultants is to help our clients 
attract, retain and motivate the leaders they need to run 
successful global companies and to advise compensation 
committees on best practices.
    Thank you for this opportunity to discuss Hewitt's 
executive compensation practices and safeguards. And we're 
happy to take questions from committee members.
    [The prepared statement of Mr. Powers follows:]

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    Chairman Waxman. Thank you very much, Mr. Powers.
    Mr. Paulin.

                   STATEMENT OF GEORGE PAULIN

    Mr. Paulin. Thank you, Mr. Chairman, members of the 
committee. My name is George Paulin. I'm the chairman and CEO 
of Frederick W. Cook & Co. Our firm has about 60 employees.
    Currently, we are independent advisors on executive 
compensation to the board compensation committees at 27 of the 
Fortune 100 companies. We've got a number of other clients with 
which we work directly with board compensation committees or, 
in fewer cases, separately with management. Our services 
include analyzing and recommending compensation levels and 
compensation program design. We advise on how much to pay and 
how to pay--the whole gamut of executive compensation.
    We provide no other services except executive compensation 
consulting. We are 100 percent owned by our senior consultants. 
We have no outside equity or reciprocal financial 
relationships. We don't sell any services or products other 
than executive compensation consulting.
    And this has been the model of our firm by design since it 
was founded in 1973, 35 years ago. And I have been with the 
firm 26 of those 35 years. We designed it this way with the 
specific purpose of avoiding business conflicts that would 
potentially compromise our objectivity in advising on sensitive 
executive compensation matters.
    There are two overriding reasons, in my mind, why board 
compensation committees need their own source of independent 
expert counsel on executive compensation. The first is a legal 
reason. I'm not a lawyer, but my understanding of Delaware law 
is that outside directors are bound by a duty of care. The duty 
of care includes the exercise of due diligence, where the use 
of expert advisors has been encouraged, as recently 
demonstrated by the decision in the Disney case. If those 
advisors aren't independent or are deemed to have a conflicting 
interest, then the directors could be at risk for not 
fulfilling their responsibility to the shareholders in terms of 
the duty of care.
    The other reason is a practical one. It's the need to 
balance resources available to and beholden to management, 
which are not only vast but inherently less than objective. 
Compensation committees don't have any staffs. They meet three 
or four times a year to make complex and often contentious 
decisions. As a matter of routine, they should have credible, 
unbiased, professional support that they can trust, in the same 
way that audit committees rely on outside accountants.
    Basic economics inevitably creates business conflict with 
regard to advising compensation committees and providing other 
services to the same corporations, especially when these other 
services are financially more lucrative. And any of my 
colleagues here will agree that revenues from actuarial 
consulting, insurance commissions, human resources, outsourcing 
services, pay-survey data bases can be tens of times executive 
compensation consulting revenues.
    To avoid such conflict, we believe that consultants chosen 
to be the independent advisors to board compensation committees 
should, in fact, be independent from management. They shouldn't 
be allowed to conduct other business with or provide other 
services to those same organizations.
    A simple solution can be taken right from the New York 
Stock Exchange rules, which would be to apply the same 
definition of independence to the compensation consultants in 
their firms that already apply to the directors who serve on 
the compensation committees.
    Assuming a definition of independence for compensation 
committee advisors similar to the one for directors in the New 
York Stock Exchange rules were adopted, then there'd be a 
question of what's the appropriate relationship between the 
independent consultant and management. Should the independent 
consultant merely serve in an audit capacity, reviewing 
analyses and recommendations prepared by management and its 
advisors, or should it work cooperatively with management in 
developing the analyses and recommendations?
    Based on many years of experience, we believe that the 
latter approach provides a better-informed and more effective 
governance process. There is conflict, maybe, but any potential 
we feel can be controlled here by simply having a sensible 
process where the compensation committees would hire and fire 
the independent consultant; make clear that the consultant's 
sole responsibility is to the committee and that any 
interaction with management is on behalf of the committee and 
as the committee's agent; approve the scope of the consultant's 
involvement that doesn't go beyond direct support for the 
committee; act directly with the consultant in identifying peer 
companies for competitive benchmarking to finding the pay 
philosophy and setting CEO pay; meet regularly with the 
consultant in executive session without management; and fully 
disclose the relationship and the fees to shareholders in the 
proxy statement.
    Thank you for the opportunity to make these comments and 
for the committee's concern with improving the fairness and 
effectiveness of executive compensation practices, which are an 
important element of the American economy.
    [The prepared statement of Mr. Paulin follows:]

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    Chairman Waxman. Thank you very much, Mr. Paulin.
    Mr. Reda.

                    STATEMENT OF JAMES REDA

    Mr. Reda. Good afternoon, Mr. Chairman, Ranking Minority 
Member Tom Davis and other members of the committee. My names 
is James Reda, and I'm founder and managing director of James 
F. Reda & Associates, based in New York City.
    I'm an independent compensation advisor to numerous 
publicly traded corporations, with over 20 years of executive 
compensation consulting experience. I'm the author of over 20 
articles and two books. My most recent book, entitled, ``The 
Compensation Committee Handbook,'' is now in its third edition. 
In addition, I was a member of the National Association of 
Corporate Directors' Blue Ribbon Commission entitled, 
``Executive Compensation and the Role of the Compensation 
Committee.''
    I am in favor of providing corporate board members with a 
higher standard of disclosure to verify the independence of 
compensation advice they receive from consulting firms. This 
recommended disclosure would be similar to that found in the 
audit committee report so crucial in making the audit process 
independent of senior management. Such an added disclosure 
could help remedy the negative perception executive 
compensation holds with shareholder groups, the public and the 
media.
    Like the audit firms before Sarbanes-Oxley, providers of 
compensation advice, which I will refer to as diversified human 
resources consulting firms, have significant economic 
incentives to provide additional services which are oftentimes 
more lucrative and beyond executive compensation. These other 
services include human resources consulting, business process 
outsourcing, information technology consulting, risk and 
insurance underwriting, and actuarial consulting.
    We estimate that compensation consulting services represent 
0.5 percent to 2 percent of the diversified HR consulting firm 
revenues. A large part of the other 98 percent to 99.5 percent 
of revenues comes from the same companies who also use 
compensation consulting services. When you combine the access 
and impact that executive compensation consultants have on a 
client with the need to sell other services, you have a 
prescription for heavy cross-selling activities where executive 
compensation consultants lead the charge and as a result are 
conflicted.
    Consider for a moment: If the firm providing advice to the 
board of directors on CEO and VP of HR pay is also providing 
other service to the CEO and VP of HR, how can the board ensure 
the consulting firm's recommendations are independent and 
objective? Even if the compensation consultant is not providing 
other services to management but has the potential to provide 
such services, the public may perceive a direct conflict of 
interest and lack of independence.
    While some diversified HR consulting firms may also use a 
Chinese wall or a firewall to separate their compensation 
advice from other consulting services, there remains the 
perception that a conflict of interest exists. A Chinese wall 
or firewall simply does not work, as shown in other areas such 
as accounting and investment banking.
    There are a growing number of independent firms like my 
firm made up of experts that formerly worked at large, 
diversified HR consulting firms. These independent experts 
continue to offer compensation advice but without any potential 
or perception of conflict of interest. The use of independent 
consulting services can only help quiet the critics of 
executive compensation, provide additional transparency to 
shareholders, and benefit American business.
    In my letter to the SEC of April 2006, I recommended that 
the Commission take action to shed light on this issue and 
improve the independence of competition committee operations by 
requiring further disclosure on compensation consultant 
independence. The recommended disclosures include, among other 
items, a table presenting fees paid to compensation consultants 
for executive compensation consulting services and all other 
fees paid to the consultant's firm or affiliated firms for 
other services. But as it stands today, the SEC disclosure 
rules stop short of requiring a detailed list of duties and 
fees. This reinforces the public perception that the 
compensation consulting profession is not helping and perhaps 
even exacerbating problems with executive pay.
    We seek to change this. My independent advisor colleagues 
and I offer no additional unrelated services to management. We 
view the compensation decisionmaking process as crucial and in 
the best interest of shareholders and American business. In 
this way, U.S. Corporations can implement executive 
compensation programs that truly pay for performance and will 
help improve our companies' credibility at home and abroad.
    Thank you for the opportunity to testify on this important 
issue.
    [The prepared statement of Mr. Reda follows:]

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    Chairman Waxman. Thank you very much, Mr. Reda. I 
appreciate your testimony.
    I'm going to start off the questioning.
    Mr. Scott, as I understand your testimony, you're the head 
of executive compensation at Mercer Consultants, one of the 
largest executive compensation firms. And your view is you 
defend current practices and have said that firms like yours 
can provide both executive compensation advice and other 
services to a company without a conflict of interest.
    But my understanding is that your own company takes a very 
different approach to executive compensation. I would like to 
ask you about this apparent double standard.
    My understanding is that Mercer Consultants is a subsidiary 
of a larger publicly traded firm, Marsh & McLennan. Is that 
right?
    Mr. Scott. Marsh & McLennan, yes.
    Chairman Waxman. I's like to read for you--I have a copy of 
their annual meeting and proxy statement for 2007, and here's 
what it says in the report: ``the committee has engaged an 
independent compensation consultant, Towers Perrin. The 
independent compensation consultant reports directly to the 
committee and does not do any work for management.''
    In other words, your own company insists on hiring 
executive compensation consultants without conflicts of 
interest. Why does your parent company have this policy in 
place?
    Mr. Scott. Our parent company has that policy in place so 
that they, like many other firms who are concerned that their 
shareholders be confident that they are getting an outside 
review of the pay practices they intend to follow for their 
executives has been given.
    Chairman Waxman. Well, doesn't this say that your company's 
board understands the problems that can occur with the use of a 
consultant with a conflict of interest, and they want to assure 
that there is not going to be a conflict of interest?
    Mr. Scott. I can't interpret the statement that way. I can 
interpret it as them wanting to assure shareholders that an 
independent review by someone who does no other work with the 
company is in the best interest of shareholders.
    Chairman Waxman. Do you advise your clients that this 
approach, hiring an independent compensation consultant, is the 
best approach to executive compensation decisionmaking?
    Mr. Scott. When we're working with clients and it's clear 
to them that they do have a worry about that, that's something 
that concerns them, that they want to be able to demonstrate to 
shareholders that independent review does occur, we do. And we 
do, as a matter of policy, recommend to them, as in our 
statement, an independent oversight model where there is 
someone who is not Mercer, who does no other work with the 
company, work with them.
    Chairman Waxman. So you have clients that utilize your 
company's executive compensation services and they also hire 
Mercer to do other work for management, but before they do 
that, you inform them that you're doing both tasks. So, 
therefore, they're deciding whether they want a separate, 
independent consultant only on compensation.
    Mr. Scott. Yes, Mr. Chairman. In 2005, well before a lot of 
the discussion and requirement, we instituted with all of our 
executive compensation relationships the requirement that, 
whether they liked it or not, we were going to tell them how 
much money we received over the last 3 years for executive 
compensation advice and how much money we received over the 
last 3 years for work we had done for management.
    Chairman Waxman. And if they want an independent 
consultant, you would refer them elsewhere? Is that how you 
handle it?
    Mr. Scott. No, we don't refer them, but we certainly 
suggest that they consider that option. And we are happy to bow 
aside or to work with that other consultant, but not as the 
independent overseer, which is a role we won't take for a 
company.
    Chairman Waxman. And, Mr. Reda, you operate an independent 
firm. What are your views on this subject? Do you think 
problems can arise when a consulting firm is cross-selling 
other services to a client?
    Mr. Reda. It's been my experience that it can arise, yes.
    Chairman Waxman. And how about you, Mr. Paulin? What do you 
think about it?
    Mr. Paulin. They can. They don't always, but it's certainly 
there, potential conflict.
    Chairman Waxman. Well, it's difficult for me to understand 
how a company like Mercer can claim that compensation 
consultant independence is not important. Its own board of 
directors obviously believes it is. There's an old adage, you 
can learn more by watching what someone does than you can by 
listening to what someone says.
    How do you respond to that, Mr. Scott? Doesn't it sound 
like your company is telling that they care about having 
independent consulting and that you, on the other hand, are not 
following that practice?
    Mr. Scott. Mr. Chairman, I would respectfully disagree. I 
think, in fact, what Marsh & McLennan Companies does is an 
exact demonstration of the way that we do work with clients, 
which is we allow them to decide how and if they want to use us 
and in what way. And if, in this particular case, Marsh & 
McLennan felt in order to assure its shareholders that it's 
receiving independent review that it retained Towers Perrin, 
who has no other relationship with Marsh & McLennan--and we 
have other clients that would similarly make those kinds of 
decisions.
    On the other hand, if they don't have a shareholder concern 
and they feel that using Mercer is the best option for them for 
whatever reason, then we'll work with them in that fashion. 
Again, going back to our global standards in which we'll work 
with them, but only on the basis they understand that there is 
going to be complete transparency in the relationship----
    Chairman Waxman. Pursuant to transparency, do you think the 
shareholders know that there is this potential conflict 
situation and they're agreeing to it?
    Mr. Scott. In the cases of----
    Chairman Waxman. Of the shareholders.
    Mr. Scott. At Marsh & McLennan?
    Chairman Waxman. No, the shareholders for the company where 
you're doing the consulting work, do they know that you're 
doing both the compensation part of the effort as well as other 
activities for that company?
    Mr. Scott. Sure. What we can do for that process is we can 
make sure that the compensation committee has that information, 
which we insist they do.
    Chairman Waxman. The compensation committee at the 
corporation?
    Mr. Scott. That's correct.
    Chairman Waxman. But not the investors.
    Mr. Scott. In some cases, we have clients who are going 
above and beyond the SEC requirements and they are sharing that 
with investors, and in other cases they're not.
    Chairman Waxman. So, in other cases, they're not.
    Mr. Scott. Right.
    Chairman Waxman. OK. So we don't know--it's hard to say 
that all of them know.
    Mr. Lowman, in your written statement you say that your 
executive pay consultants do not receive any compensation for 
selling other work to their corporate clients. This is one of 
the ways in which you attempt to manage the conflict of 
interest, by trying to make sure your pay consultants aren't 
cross-selling other services and, thus, dependent on the 
executives whose pay they provide advice on.
    But job postings from your company seem to contradict your 
position. They show that you do place a premium on cross-
selling. I believe we can display an exhibit, and we'll ask our 
staff to hand it to you.
    Mr. Lowman. Thank you.
    Chairman Waxman. This is a recent Towers Perrin job notice 
for an executive compensation consultant, and it lists the job 
responsibilities. It says, ``The applicant will be cross-
selling consulting and other Towers Perrin services to existing 
and new clients.'' It also says, ``Minimum revenue generation 
from all sources, i.e., not just executive compensation 
services, goal of $750,000 in the first 12 months would be 
expected.''
    So that's confusing to me. You've told the committee you 
don't encourage cross-selling other services to management 
because this could impede your independence, yet this job 
notice indicates that cross-selling is a critical part of the 
job of compensation consultant. How do you explain this 
conflict?
    Mr. Lowman. The job posting--the $750,000 is an important 
number because that indicates that it's a fairly junior 
position in Towers Perrin. Typically, someone that's consulting 
to a board, someone that's consulting to senior management 
would be responsible for many more millions of dollars in 
services. This is a junior-level position that would not be 
advising on senior----
    Chairman Waxman. But it does say you expect them to cross-
sell----
    Mr. Lowman. Yes, let me explain.
    Chairman Waxman [continuing]. As part of their 
responsibilities.
    Mr. Lowman. I'll continue my answer, Mr. Chairman. This is 
a junior-level position. They would be responsible for working 
inside an organization in support of whatever kinds of 
incentive design might be done for middle management, perhaps 
for sales, compensation and so forth. It is not for a position 
that would be advising the CEO or advising the chairman of the 
compensation committee.
    Actually, I want to reaffirm what I said in the written 
testimony, which is that our board-appointed compensation 
consultants do not get involved in cross-selling services for 
any other part of Towers Perrin.
    Chairman Waxman. They don't.
    Mr. Lowman. They don't.
    Chairman Waxman. But the company does.
    Mr. Lowman. I'm sorry?
    Chairman Waxman. Those consultants don't, but the company 
does.
    Mr. Lowman. We have a broad-based consultancy, and we work 
in a number of different areas. Other people within our 
organization will have responsibility for selling services to 
various clients, whether they're executive compensation clients 
or not.
    Chairman Waxman. Mr. Paulin and Mr. Reda, do you have any 
comments on this? You've had long experience in the field. Do 
you think cross-selling occurs at firms like Towers Perrin and 
other multi-service consultants, even though they have 
different people doing different jobs, or is there still the 
same problem?
    Mr. Paulin. My sense of the work that's done by executive 
compensation consultants, those people who are very senior and 
who are advising boards of large companies, is that they are 
not paid directly to cross-sell to those companies, as a 
policy. I believe that to be true.
    I also believe that there are corporate rewards. So Mr. 
Scott probably receives stock options in the stock of Marsh & 
McLennan that reflects the overall economics of the 
organization. And I think those are part of the overall 
compensation program for the senior people.
    Chairman Waxman. Mr. Reda, do you have any comment?
    Mr. Reda. Well, it's been my experience that, say, maybe 3 
years ago, maybe 4 years ago, it was a free-for-all, that you 
did see cross-selling from the compensation consultant that was 
advising the board, and it was pretty blatant. That now, for 
these firms here, has been restricted to some degree.
    But do you have to see that these consultants are part of a 
bigger organization. They hold stock in the actual organization 
that they're a member of. So, depending on how well they do 
selling--and you heard that there's goals for people to sell 
and to do and so forth--it's all economic, that the more they 
sell, the more they earn their retirement and increase their 
wealth.
    So my feeling is that these Chinese walls and firewalls do 
not work because of the economic interest of the people who 
work for the firm, they are essentially tied at the hip 
economically, and it's impossible to break that tie.
    Chairman Waxman. Thank you very much.
    Mr. Davis.
    Mr. Davis of Illinois. I'll pass to Ms. Foxx.
    Chairman Waxman. Oh, OK.
    Ms. Foxx.
    Ms. Foxx. Thank you, Mr. Chairman.
    I'm going to ask one question of each of you.
    And, Mr. Reda, if you would start, and then just go down 
the line. This just requires a yes or no answer.
    Do you believe that your firm has adequate safeguards to 
address Chairman Waxman's concerns?
    Mr. Reda. Yes.
    Mr. Paulin. Yes.
    Mr. Powers. Yes.
    Mr. Scott. Yes.
    Mr. Lowman. Yes.
    Ms. Foxx. OK. Thank you.
    I have another question then. Mr. Lowman, this one's for 
you. In Daniel Pedrotty's testimony, he said your organization 
advised Merrill Lynch board of directors compensation 
committee, has advised them since 2003, but that you also 
provide other consulting services to Merrill Lynch that are not 
related to executive compensation.
    Do you believe this dual role endangered the impartiality 
of your compensation consultants? And explain. If you say yes, 
then explain why. If you say no, you can explain why not.
    Mr. Lowman. I suspect you're not going to be surprised to 
hear me say no, I don't believe it endangered our objectivity. 
What I'd like to do is just expand on that a bit, if I may.
    I think there is an underlining assumption, make assertion, 
that somehow having a so-called independent advisor--and I say 
so-called because I believe that all of us can operate and do 
operate independently--but to have a so-called independent 
advisor who does no other work elsewhere in the organization 
will either result in better pay, lower pay. Maybe there's an 
assumption that he who pays least pays best.
    But, indeed, going back to Mr. Pedrotty's repeated 
references to the Corporate Library report, I thought it was 
interesting that he did something that we advise our 
consultants never to do, if you're going to be objective and if 
you're going to be responsible, and that's to cherry-pick data. 
Mr. Pedrotty cherry-picked probably the least important piece 
of data in that report, which was base salaries. As anyone on 
this panel will tell you, if a CEO is making $15 million, 
probably half or more of that is in stock options or in stock 
compensation. And referring to that very report which Mr. 
Pedrotty cherry-picked from, on page 7 of that report it talks 
about the biggest piece of compensation, which is the stock 
piece, and the top four firms there that are the greatest 
percent above median stock option value are Radford, Frederick 
W. Cook, Pearl Meyer and Compensia.
    So if the assertion is that what you refer to as an 
independent advisor who does no other work of any sort is going 
to result in lower pay or somehow better pay, this report 
that's continually referenced by Mr. Pedrotty would suggest 
that's patently untrue.
    Ms. Foxx. And a followup, if I might, to that. I believe 
you said in your prepared testimony that the report from 
Corporate Library shows, indeed, that independent compensations 
determined by, again, those so-called independent consultants 
are higher than those that are recommended or set by what I 
would call comprehensive firms or firms that do multiple tasks.
    Mr. Lowman. Yes, ma'am. If I may, I don't want to give too 
much credence to this report, because, again, I would defer to 
my colleagues on this panel. I can't testify to the credibility 
and validity of this report. But if we're going to reference 
it, then we should reference what's in it fully and not cherry-
pick the information.
    I think that it's a very important point that not one of us 
on this panel has their integrity for sale. The reputations of 
our company are not for sale. We operate with integrity. We 
consult to compensation committees of the board. Occasionally 
we consult to management. The compensation committees need to 
make the decisions--indeed, do make the decisions--about 
executive pay. We provide advice. They may choose to accept it; 
they may choose not to. And at times I don't know why they 
don't accept some of the advice I give them because I think 
it's a lot better than what they adopt, but they do what they 
do.
    Ms. Foxx. Thank you, Mr. Lowman. I appreciate your pointing 
out again in an indirect way that the decisions these 
corporations are making are made freely. Stockholders buy stock 
freely. Boards make their decisions. As you say, you may give 
them advice, but nobody is holding a gun to their head to make 
them do this.
    Mr. Powers, I'd like to ask you one additional question. 
There has been an analogy made between compensation consultants 
and accounting firms. Do you think that's an accurate analogy? 
And, again, whatever way you answer, please explain a little 
bit why you feel that way.
    Mr. Powers. Congresswoman Foxx, we do not agree that it's a 
completely analogous situation to the audit role. We think 
there are several significant differences between the role we 
provide as compensation consultants and the role that outside 
auditors provide to public companies. Some of those would 
include that public companies are required to have an outside 
auditor. It is also required that they report directly to the 
audit committee. They are approved by shareholders, and their 
primary function is to certify as to the veracity of the 
financial statements. Those financial statements are relied 
upon by third parties like investors and lenders.
    On our side of the shop, there really aren't any specific 
GAAP-like standards for us to follow. And there is no report 
that we publish that investors or other third parties rely on.
    Chairman Waxman. Thank you for your questions.
    Mr. Davis.
    Mr. Davis of Virginia. Thank you, Mr. Waxman.
    On panel one, Professor Elson testified that most board 
members don't inquire about potential conflicts of interest 
among compensation consultants. Let me just ask each of you, do 
you agree with Professor Elson, based on your firm's 
interaction with board members?
    Mr. Lowman.
    Mr. Lowman. Compensation committees are very concerned 
about conflicts of interest of all types, not just whether or 
not you're doing work elsewhere in the organization. Yes, they 
are concerned, and they do inquire about it.
    Mr. Davis of Virginia. Mr. Scott.
    Mr. Scott. I would echo that, as well, and, in addition, 
point out that, even were they not to ask, through our global 
standards we require that they have that information.
    Mr. Davis of Virginia. OK. Thank you.
    Mr. Powers. I would agree with that as well, Congressman 
Davis. We regularly advise our clients to have that 
conversation. They are the ones who are both making pay 
decisions and also assessing whether the advice they're getting 
is objective or not. And they are certainly not required to 
have an advisor in this capacity. And I think if they weren't 
serious about finding out if we had conflicts that they were 
uncomfortable with, they would not be turning to us for this 
kind of advice.
    Mr. Davis of Virginia. Mr. Paulin.
    Mr. Paulin. I think most large companies and their boards 
both recognize and accept that best practice is to have an 
independent consultant. And they would, in that definition, 
view potential business conflict as a concern.
    When you get down into smaller companies--and I'm still 
talking about public companies, but middle-market, small-cap 
companies--the sophistication and resources sort of falls off. 
So I'm not sure I would make the statement as generally down 
there as I would for the S&P 500.
    Mr. Davis of Virginia. And the compensation is not as large 
for the smaller companies.
    Mr. Paulin. I'm sorry?
    Mr. Davis of Virginia. The compensation is not as great, 
either, for the small companies.
    Mr. Paulin. Yes, that's correct.
    Mr. Davis of Virginia. OK.
    Mr. Reda.
    Mr. Reda. It's been my experience that it's about 50/50. 
Half do; half don't. And I'm surprised to learn that there is a 
full disclosure at the time that the engagement is entered 
into. A lot of the board members I deal with haven't really had 
that full disclosure, to the best of my knowledge, in actual 
dollars, who was paid what, when and for what services. So, 
again, my experience is about half do and half don't.
    Mr. Davis of Virginia. Let me ask this. You make 
recommendations on ranges, I gather, of what salaries and the 
package ought to be. How often do they take your suggestions 
verbatim, and how often do they make significant changes from 
that?
    Mr. Lowman. That's hard to quantify, to be honest with you. 
I'm going to guess, I'd say more often than not they'll take 
our recommendations--not verbatim. You know, typically there's 
discussion. And I think----
    Mr. Davis of Virginia. Ballpark basically. Is that----
    Mr. Lowman. Yeah, I think it is really important to 
understand a couple of things here. I mean, I don't know how 
many----
    Mr. Davis of Virginia. At these levels, it's basically 
negotiated at the end, isn't it? Don't usually they have the--
--
    Mr. Lowman. This is what I want to get to.
    Mr. Davis of Virginia. Yeah.
    Mr. Lowman. You know, all of us have the experience of 
working with a lot of companies over may years and seeing how 
this works.
    Mr. Davis of Virginia. I was general counsel to a public 
company before I came here.
    Mr. Lowman. So you know a lot about it.
    Mr. Davis of Virginia. I have any own reference point, but 
that's one company. I want to hear yours.
    Mr. Lowman. So my experience is that we'll come in giving 
observations about competitive practice. We'll put that 
competitive practice in context, usually in the context of 
performance, corporate performance. And then there is a lot of 
discussion that the compensation committee members enter into, 
with respect to how did the CEO, him or herself, actually 
perform the job, how did the corporation do, how did they 
follow through on various initiatives.
    And so we can provide ranges of what we think some sort of 
reasonable practice might be, but the compensation committee 
will triangulate on a number. Typically it's not formula-
driven. Typically there's a lot of reference to performance.
    Mr. Davis of Virginia. Your recommendation is just one of a 
number of factors in the final product.
    Mr. Lowman. Absolutely.
    Mr. Davis of Virginia. Mr. Scott, is that your observation, 
as well?
    Mr. Scott. That would be our observation, as well, that the 
process in fact is one where we're working together to find the 
right solution. And because part of what we're doing is 
hopefully asking the right questions about what industries they 
need to compete in and how competitive they need to be and 
whether they want to structure the package more to reinforce 
short-term or long-term performance, that through that question 
process we're going to eventually get down to a prescription, 
that then our job is to help----
    Mr. Davis of Virginia. Well, let me ask this. Generally, at 
the level you're talking about, you're not talking about 
bringing somebody from unemployment that you're offering them a 
job. You're sometimes wooing them from other attractive jobs. 
Is that right? So it's very market-based.
    Mr. Scott. Well, that is correct. Usually in those cases 
where you are heading outside to find a candidate, they are 
very comfortably paid and protected where they are.
    Mr. Davis of Virginia. Mr. Powers, what's your observation? 
Similar?
    Mr. Powers. To your original question, Congressman, you had 
asked how often do our compensation committee clients take our 
advice, and I'd say they certainly use our advice, trust our 
advice as one of the important factors in determining executive 
pay. However, they really have their own process. We've seen a 
much better, I would say, corporate governance process over the 
last couple of years in particular, where we are seeing more 
robust debates about executive pay. The committee members are 
more informed about executive pay. They are asking us to 
provide more information as backdrop to their decision. But 
ultimately it is their decision on both how much and what form 
of pay.
    Mr. Davis of Virginia. Let's ask the two----
    Mr. Paulin. It's pretty common for compensation committees 
not to act directly upon what I recommend. It's much less 
common for them to act on something that I seriously object to.
    Mr. Reda. It's been my experience that what we provide to 
compensation committees and boards is very complex; it's a lot 
of numbers, statistics. And depending on how the information is 
prepared, you can point the committee in one direction or 
another. That was my first point.
    And my second point, they typically use what we give to 
them as a guideline. And about three-quarters of it is 
approved, ultimately, in the form that we present it, at least 
in my experience.
    Mr. Davis of Virginia. Thank you.
    Chairman Waxman. Thank you, Mr. Davis.
    Mr. Danny Davis.
    Mr. Davis of Illinois. Thank you very much, Mr. Chairman.
    Our first panel of experts today gave us one prescription 
for solving the problem of conflicts of interest among 
executive pay advisors, and that was disclosure for them. At 
the very least, investors and the public should know if a 
compensation consultant has a conflict of interest.
    Mr. Scott, your testimony highlights the need for your 
company to have, ``a clear and transparent relationship with 
clients.'' Do you believe that your clients, the Fortune 250 
companies, should have the same relationship with their 
investors?
    Mr. Scott. Congressman Davis, thank you.
    We do provide that transparency to every single 
relationship, and I think they value that. And it helps them 
manage the potential conflict that they deal with--one of many 
potential conflicts they deal with all the time.
    It's really not my position or Mercer's position to say 
whether their investors should have that same sort of 
transparency. I will tell you that several clients have 
voluntarily made the decision to do that.
    Mr. Davis of Illinois. Well, by this standard, then, do you 
think that companies should be disclosing if their compensation 
consultant has a conflict of interest?
    Mr. Scott. Congressman Davis, I would only disagree with 
what you were saying, because I make a distinction between a 
potential for conflict of interest and a conflict of interest. 
There are many potential forms of conflict. One certainly comes 
about when you have a relationship with a compensation 
committee and another part of your firm has a relationship with 
management. But there are other forms of potential conflict, as 
well, even if you only have a relationship with a compensation 
committee.
    And I would say, in all of those cases, the transparency of 
the relationship is the thing that those in the decisionmaking 
role need in order to perform their role, which is to manage 
the potential for conflict.
    Mr. Davis of Illinois. Thank you.
    We heard from institutional investors earlier this morning 
that they actually want this information. We also saw that a 
wide range of experts on corporate governance say that this 
independence is critical.
    If you would and if you could, I would like to ask if each 
one of you would answer these two questions for me with a yes 
or no, perhaps just beginning with you, Mr. Lowman.
     If investors considered it important, shouldn't they have 
the right to know if a pay advisor is being paid for other work 
by management?
    Mr. Lowman. I think if an investor wants to have that 
information, the investor should be provided the information.
    I do want to--may I just add one clarifying remark to that? 
I think that, to Mr. Scott's point, there may be an apparent 
conflict but not necessarily a real one. And the other point 
I'd like to make is that simply providing a number does not 
necessarily provide insight into the nature of the 
relationship.
    Mr. Davis of Illinois. Mr. Scott.
    Mr. Scott. Congressman Davis, I'd like to answer--you 
mentioned two questions, though. I have the one about whether 
investors should receive that information about the fees. Was 
there a second?
    Mr. Davis of Illinois. Well, I didn't mention the second 
one yet, but whether or not companies should be required to 
disclose when their consultant has a conflict of interest.
    Mr. Scott. OK. I can't answer those yes/no. I'll go ahead 
and answer them if you'd like me to, but they don't lend 
themselves to a yes/no answer.
    Mr. Davis of Illinois. All right.
    Mr. Scott. Would you like me to answer?
    Mr. Davis of Illinois. Yes, go right ahead.
    Mr. Scott. To your first question, again, I would say that 
it's not Mercer's and it's not a compensation consultant's role 
to make policy in investor relations with companies. And so, 
our answer there--that would be our answer there.
    With regard to your second point about whether companies 
should disclose whether the consultants they use have 
conflicts, again, I cannot agree with the underlying question, 
because I don't think that the potential for conflict means 
there is a conflict.
    Mr. Davis of Illinois. All right.
    Mr. Powers.
    Mr. Powers. To your first question, Congressman, our 
position is really the SEC has evaluated that issue fairly 
carefully and has made a decision. Up until recently, there was 
no disclosure of the compensation consultant. With the new 
disclosure rules, for consultants who are involved in either 
determining or recommending executive pay, the company has an 
obligation to identify both the consultant, who engaged the 
consultant and some specifics about the roles and 
responsibilities.
    We believe the SEC thought that was a reasonable balance 
between investors' needs in that context. But I think from a 
policy standpoint we believe, again, that the compensation 
committee is the body that really has to make a determination 
on whether they're getting credible, objective advice or not. 
And, again, our policy is to provide them with all the 
information they need to make that assessment, and then it's up 
to them to decide.
    Mr. Davis of Illinois. Mr. Paulin.
    Mr. Paulin. Congressman Davis, I think it would be simple 
enough to give investors the confidence without any real 
regulatory baggage that compensation consultants are 
independent, the same way that members of compensation 
committees are independent, which is why I suggested in my 
testimony that the New York Stock Exchange independence test be 
used.
    Now, I can say I'm independent because I don't provide any 
other services. But what if I'm advising General Electric and 
my brother-in-law is the CEO of General Electric or I'm a 
former employee who's getting a pension from them or who has 
stock options, that type of thing? All of this is covered by a 
simple rule, and it goes beyond just cross-selling services. 
And I think something like that could be very easily used to 
address this problem.
    Mr. Davis of Illinois. Mr. Reda.
    Mr. Reda. Well, as a starting point, I would say, yes, the 
fees for executive compensation consulting services should be 
disclosed, as well as all other services, including affiliated 
companies.
    The second question is, yes, if there's any conflicts, 
including potential conflicts, which is the fee disclosure 
aspect to the answer to the question, yes, I think that should 
be disclosed. I don't think that the outside consultant should 
be called independent if they are providing substantial other 
services to the company.
    Mr. Davis of Illinois. Thank you very much, Mr. Chairman.
    Chairman Waxman. Thank you.
    Mr. Tom Davis.
    Mr. Davis of Virginia. Yes, I just have one question. And, 
Mr. Reda, I'll address it to you, and Mr. Paulin.
    Large corporations, certainly like any company in the 
Fortune 250, are likely to have a host of subsidiaries, 
subdivisions, many of which are far removed, operationally 
speaking, from either the parent entity or each other.
    In such large corporations, don't you think it's far less 
likely that a consulting firm that is providing non-
compensation consulting services to a particular corporate 
subdivision would face any kind of conflict when it comes to 
also providing pay advice to the parent company's compensation 
committee and board?
    Mr. Reda. I'll answer first.
    Yes, I think if there was other compensation consulting 
services to a subsidiary in another country totally unrelated 
to compensation, I could see that's not as conflicting. But it 
should be disclosed.
    Mr. Davis of Virginia. Mr. Paulin, do you agree with that?
    Mr. Paulin. Yes. I mean, I think that there should be full 
disclosure of potential conflicts.
    Mr. Davis of Virginia. But neither one of you would favor 
an absolute bar. If it's disclosed, that would be it, and then 
the board would be forewarned, and then they could 
appropriately make a decision?
    Mr. Paulin. Generally, to me, more important than 
disclosure would be some rule or definition for independence 
that could be applied. And if that were applied, then I don't 
know why additional disclosure would be necessary. If people 
knew that if I were the independent consultant I met certain 
independence tests, then maybe we wouldn't need disclosure.
    Mr. Davis of Virginia. I mean, I'll just tell you, if I sat 
on a corporate board and I overcompensated somebody based on--I 
mean, I would be scared to death. We make it sound like being 
on a board is such a great thing, but with the lawsuits out 
there today, not everybody wants to serve on a board and 
subject themselves to that kind of potential liability. You put 
everything at risk. And I'm sure these questions are asked on a 
pretty consistent basis by wide-awake board members.
    But I appreciate everybody's input into this thing. I think 
it's been illuminating to us. I don't see any reason for 
governmental intervention at this point. I think it's always 
important for the industry to come up with its own standards, 
and corporations, as they move ahead. But thank you very much.
    Chairman Waxman. Thank you, Mr. Davis.
    I want to thank the panel for your testimony.
    I just want to conclude by saying there are millions of 
Americans, when they look at the soaring amounts that CEOs are 
getting paid in this country, they think the system's rigged. 
And I can't see what objection there would be that this 
potential conflict or apparent conflicts of interest at least 
be disclosed. As long as major companies hire consultants where 
there is no information to everyone involved, including the 
investors, that there's a potential or apparent conflict of 
interest, I think that cynicism of the American people will 
continue.
    All right. Thank you all very much. We, I think, gave an 
airing to this issue, and your testimony was very helpful.
    That concludes our hearing today, and we stand adjourned.
    [Whereupon, at 1:32 p.m., the committee was adjourned.]
    [The prepared statement of Hon. Bill Sali follows:]

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