“The gatekeeper is an agent who acts as a reputational intermediary to assure investors as to the quality of the ‘signal’ sent by the corporate issuer. The reputational intermediary does so by lending or ‘pledging’ its reputational capital to the corporation, thus enabling investors or the market to rely on the corporation’s own disclosures or assurances where they otherwise might not.”12 Since the gatekeeper is the repeat player in the capital market, its success depends on its reputation which has accumulated for quite a long time. In theory, “because the gatekeeper’s business depends on its reputation for honesty, probity, and accuracy, it will not ruin that reputation to aid one client to cheat.”13 Based on the characteristics of gatekeeper, the compensation consultant in China who issues professional opinion on the reasonableness of stock option plan, is definitely, one kind of gatekeepers. In the US and UK, a compensation consultant also plays the role of justifying the decisions made by the compensation committee, so this chapter also regards it as one kind of gatekeepers. Here, I want to emphasize three points:
(1) Those who a gatekeeper should really serve are the shareholders not the executives. But, in reality, the gatekeeper always colludes with the executives.
(2) Though independence is a necessary condition but not a sufficient condition for a gatekeeper to provide objective and fair opinion, the independence is the solid foundation for it to perform its duty successfully.
(3) Good reputation can help a gatekeeper gain the trust of shareholders, so it has the incentive to maintain and enhance its reputation. But only good reputation is far from enough. “The central theoretical point is that reputational arguments related to gatekeepers are complex and reputation alone is not necessarily a viable constraint on
12 John C. Coffee Jr., Gatekeepers: The Professions and Corporate Governance (London: Oxford University Press, 2006), at 2.
13 Stephen M. Bainbridge, Corporate Lawyers as Gatekeepers, at 1(UCLA School of Law, Law-Econ Research Paper No. 12-03, January 6, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1980975.
gatekeeper certification.”14 The reasons are: (a) It is difficult for shareholders to evaluate the opinions issued by gatekeepers; and (b) The employees and the firms have different interests, so the employees will do something benefiting themselves even at the costs of the firms. As for the case of accounting firm, “it matters little that the accounting firm is huge with hundreds of large clients. The individual audit partner has only a few. As a consequence, at the level where the most important decisions are made regarding financial statement disclosures, the balance of power lies with the client.”15
2. The roles of a compensation consultant
In the US and UK, a compensation consultant can play three different kinds of roles:
(1) providing professional advice and assistance to independent directors in the compensation committee; (2) legitimizing the compensation committee’s decisions;
and (3) serving as a intermediary between shareholders and the company.16 Because a compensation consultant takes an active part in the whole process of drafting the compensation package, its primary role is to advise the compensation committee to make compensation decision. The situation in China is a little bit different. The primary role of a compensation consultant is to legitimize the stock option plan made by the board and compensation committee. But such a difference cannot be exaggerated. On one hand, when a compensation consultant legitimizes the decision in China, it may communicate with the board and compensation committee at the same time. Suppose that some articles in the stock option plan are not reasonable from the perspective of shareholders, the compensation consultant may suggest the board and the compensation committee to amend these articles and provide their advice.
From this point of view, the compensation consultant in China can also help the board and the compensation committee to make compensation decision and address the problem that the independent directors in the compensation committee lack of experience and necessary information in making executive stock option compensation.
On the other hand, if the decision recommended by a compensation consultant is strongly criticized by shareholders in the US and UK, its reputation will be hurt. As a result, the compensation consultant will carefully choose its recommendations. From
14 Frank Partnoy, Strict Liability for Gatekeepers: A Reply to Professor Coffee, 84 B.U. L. Rev. 365, 367 (2004).
15 Richard L. Kaplan, Mother of All Conflicts: Auditors and Their Clients, 29 J. Corp. Law 363, 367 (2004). Also see Frank Partnoy, Barbarians at the Gatekeepers?: A Proposal for a Modified Strict Liability Regime, 79 Wash. U. L.Q. 491, 502 (2001) (“Even if gatekeeper managers do not face incentives to deplete the reputation of the entity for short-term gain, lower level employees might face precisely those incentives. It is especially costly to monitor such employees, given the annual bonus compensation structure of most gatekeepers and the incentives for employees to maximize short-term profits.”).
16 Bender, supra note 4, at 3-9.
this perspective, the compensation consultant supervises the compensation committee’s decision. Besides, as a reputational intermediary in the capital market, the compensation consultant can explain the company’s compensation decision and policy to shareholders and feedback shareholders’ concerns to the company. In short, not matter in China or in the US and UK, the compensation consultant can play three different roles, but its primary role is not the same. Specifically speaking:
(1) A compensation consultant can provide professional advice and assistance to independent directors in the compensation committee (the primary role of compensation consultant in the US and UK )17
a. When the compensation committee makes compensation decision, it need refer to the executives’ compensation level and structure in the same industry as its benchmark. But the company itself has no such data or its data is not enough. “The (compensation) consultants are privy to pay data that are not shared directly among companies. Firms participate in consultant’s compensation surveys with the understanding that individual company data will be kept confidential. The consultants then use the date to improve the design of their clients’ compensation arrangements.”18
b. Making executives’ compensation is a knowledge-and-experience-demanding job, it involves “the value of complex pay packages and associated tax, disclosure, and accounting issues.”19 So, with the help of a compensation consultant, the problem that independent directors in the compensation committee lack of information and experience can be addressed.
(2) A compensation consultant can legitimize the board or/and compensation committee’s decision (the primary role of compensation consultant in China)20
Because there is no world-widely recognized level and structure of executives’
17 See United States House of Representatives Committee on Oversight and Government Reform Majority Staff (hereafter the 2007 Congress Report), Executive Pay: Conflicts Of Interest Among Compensation Consultants, at 1 (December 2007), available at http://www.erieri.com/PDF/Executive-Consultant-Conflicts.pdf. (“Large companies routinely retain compensation consultants to provide advice on executive pay, such as developing compensation peer groups, designing equity compensation plans, conducting compensation surveys, and analyzing the tax, accounting, and legal implications of specific pay packages. These consultants can be retained by either the corporate board (typically, the compensation committee of the board) or management, and they may advise the board, management, or both on executive pay issues. Whether retained by the board or management, these consultants can have a major impact on executive pay decisions.”).
18 Lucian Bebchuk & Jesse Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, MA: Harvard University Press, 2004), at 70.
19 Conyon, supra note 1, at 408.
20 Ruth Bender, Paying For Advice: The Role of the Remuneration Consultant in U.K. Listed Companies, 64 Vand. L. Rev. 361, 363-364 (2011) (“It suggests that the use of compensation consultants can be best explained using theories of legitimacy: by taking outside advice, the compensation committee legitimizes its decisions in the controversial area of executive pay.”).
compensation,21 if the board or/and compensation committees’ decision is advised or checked by a compensation consultant, their decision will be immunity from being criticized by shareholders or lawsuits.22 As a result, to “employ and rely on compensation consultants have become prevalent within judicial opinions and corporate best practices.”23 In fact, courts “have generally given greater deterrence to board decisions that relied on advice by outsiders,”24 thus, “compensation consultants can similarly add legitimacy to board compensation decision in the eyes of others.”25
(3) A compensation consultant can serve as a intermediary between shareholders and the company
Only executives’ compensation is accepted by shareholders, will the board and compensation committee be avoided of being criticized, blamed or even sued by them.
On one hand, the compensation consultant can explain how and why the executive are paid for shareholders, thus quelling potential public outrage over executives compensation. This function is quite important in those counties that grant the shareholders the rights of say-on-pay. On the other hand, the compensation consultant can provide the concerns of shareholders, especially the institutional shareholders to the company. So, it can improve the understandings of both sides.
The premise that a compensation consultant can successfully play the three roles is to maintain its independence. However, independence is the “Achilles Heel” of a compensation consultant. “The core criticism is that (compensation) consultants are not sufficiently independent or impartial and this leads to pay packages that are not optimal from the shareholders’ perspective.”26