Conflicts of interest for remuneration advisers are big news offshore. We provide a checklist for Australian boards.
Conflicts of interest for auditors have been vigorously, and to a large extent successfully, tackled in the US and throughout the OECD countries since the Enron collapse and Arthur Anderson dissolution. The means varied, from outright banning of certain services to audit clients in the US, to softer but equally effective disclosure requirements in Australia, the UK and elsewhere. Now it is the remuneration advisers’ turn.
Remuneration advisers and their firms’ relationships with both the board and management are under the microscope in the US. United States House of Representatives (Democrat) Member Henry Waxman is requesting information from six executive compensation consulting firms regarding their services to U.S. corporations. Waxman chairs the House of Representatives Committee on Oversight and Government Reform and he requested the information as part of an inquiry the committee is conducting into executive compensation practices, including the compensation consultants’ role and potential conflict of interests.
The letters were sent on May 8 to Pearl Meyer & Partners, Towers Perrin, Frederick W. Cook & Co., Mercer Human Resources Consulting, Watson Wyatt and Hewitt Associates.
Only three of these firms provide executive remuneration advice to Australian companies. However, unlike the US (where it is effectively banned by the Sarbanes Oxley Act), audit, tax and financial advisory firms in Australia and the UK can also, and in fact do, provide executive remuneration advice to company boards and other services to management (although, to be fair, some of the audit firms’ codes of practice explicitly do not allow this as a potential conflict of interest).
In their response to the letter, Waxman requested the firms provide information related to their services for the top 250 companies (measured by revenue in the 2007 Fortune 500 list). The letter requested the consultants include a company if their firm provided both executive compensation consulting and other types of services between Jan. 1, 2002 and Dec. 31, 2006. The letter sets a May 29, 2007 deadline for information to be provided to the committee.
For each company identified, the House committee is requesting a description of:
• The nature of the executive compensation consulting services provided to the company
• The total revenues received annually for providing executive compensation consulting service
• The nature of all other services (other than executive compensation consulting services) provided to the company and
• A report of the total revenues received annually for providing these other services.
Corporations rely on outside firms to provide advice to directors on how to compensate senior executives. The Oversight Committee is conducting a preliminary inquiry into executive compensation practices, including the role played by executive pay consultants.
Recent press reports and company disclosures have raised questions about the independence of the advice companies receive from executive compensation consultants. In some cases, the firms that provide executive pay advice to a company’s board also perform other types of services for company management, such as employee benefit plan and pension plan consulting. In Australia and the UK this also typically includes tax, financial and other consulting from the large audit firms.
Shareholders and investors have expressed concerns that a compensation consultant’s on-going business relationships with a company could compromise the independence of the advice the consultants provide to the company’s board about executive compensation. Little is known about the extent of this practice however, because the Securities and Exchange Commission does not require companies to disclose whether executive compensation consultants perform other services to management.
However, at least in the US, Canada and the UK investors get to know whom the board receives advice from. These are required disclosures in the company’s remuneration reports. There is further information buried in UK annual reports to assist determining if there is a conflict of interest.
There are no board adviser disclosure requirements for Australian companies (although several companies voluntarily provide this information). In fact, not only is it common for board remuneration advice firms to provide a range of non-remuneration services to an Australian company’s management, they are also frequently engaged by the management to provide the advice submitted to the board, with no separate external and independent advice provided to the board at all.
Is this important? Indications are that it can be. There have already been reports in the New York Times and other papers indicating that companies with relatively lucrative executive remuneration tend to exhibit the following features:
• They employ board remuneration advice companies
• These same advisers also have been employed by management
• The management work consists of much higher fees than the minor fees associated with advising the board on executive remuneration
In one instance where there have been claims of conflicts of interest, the CEO received huge severance pay for poor performance. While the cost of the board advice for this service was under $150,000, the same advisory firm pocketed several million annually providing other services approved by management.
The extent of the problem in Australia is yet to be revealed. Before then, it may be useful for Australian board remuneration committees to have a checklist of requirements before receiving external advice:
• Does the board adviser provide any services to management?
• Are these services in remuneration advice or other areas?
• What have been the fees received by the prospective adviser for services to management?
• What other services does the firm provide that could be provided to management at a future date?
• Has the adviser a policy on dealing with conflicts of interest?
• To what extent should the directors’ remuneration report disclose the source of its remuneration advice, and the conflicts of interest associated with each source?