Executive Pay and Independent Compensation Consultants

My paper, Executive Pay and “Independent” Compensation Consultants, which I co-wrote with Kevin J. Murphy, analyzes two primary sources of conflicts of interest between consultants and their client firms. First, consultants have a conflict of interest whenever they design the pay packages of the same executives that have the power to reappoint them. Consultants who are hired by, or who work for, top management (rather than the board) have clear incentives to please the firm’s top executives by recommending generous pay packages. Second, while some consultants are “boutique” firms focused exclusively on executive compensation, many are large integrated corporations offering a full-range of compensation, benefits, and actuarial services, and therefore there is an incentive to cross-sell additional services. Consultants recommending a lower-than-expected level of CEO pay can jeopardize the opportunities to cross-sell other more lucrative services to the firm.

We use newly disclosed SEC data for 938 firms to investigate whether these conflicts of interest between consultants and their client firms lead to higher pay for CEOs, other top executives, and outside directors. We test the “repeat business” effect (i.e., the consultants’ concern with being reappointed) by examining whether pay is related to proxies for managerial influence over the decision to appoint (or reappoint) consultants, including whether the consultant is retained by the compensation committee or by management, whether the consultant works exclusively for the committee or also works for management, and whether the consult is described as “independent” in the company proxy statement. We test the “other services” effect by examining voluntary disclosures related to such services in the proxy statements, and by merging our data with 5500 filings with the IRS and Department of Labor that identify which of the consultants used by each of our sample companies also provide actuarial services to those firms.

We find that executive and director pay is higher in companies retaining consultants for pay advice than in companies not seeking advice, even after controlling for size, industry, and the mix of pay. However, we find no evidence that the higher pay is related to conflicts of interest: CEO pay is higher (and not lower) in companies where the consultant works exclusively for the compensation committee rather than management, and CEO pay does not increase when the consultant provides actuarial or other services to their client firms. Interestingly, we do find that pay is higher when the companies retain more than two consultants, suggesting perhaps that companies “shop around” until they get the answer they like!

The full paper is available for download here.