[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
EXECUTIVE PAY: THE ROLE OF COMPENSATION CONSULTANTS
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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/
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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
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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
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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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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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