compensation
Whether aforementioned two conflicts of interest of compensation consultant will lead to grant executives excess or less pay-for-performance compensation, empirical and Watson Wyatt. After 2010, Towers Perrin and Watson Wyatt conducted a friendly merge, Towers Watson is their new name. See Conyon, supra note 1, at 406. Besides, a few medium-firms can also provide compensation consultancy service to companies. In China, investment consultant firms, financial consultant firms and securities companies can provide compensation consultancy service. In such a cruel industry,
“competition could do more harm than good. The credit-rating agencies, which have historically faced little or no competition, appear to have remained largely uncaptured by their corporate clients—even if they were slow to respond to new information. Thus, the SEC has long feared that new entrants into this market would produce a ‘race to the bottom’ that lowered standards. In contrast, securities analysts during the 1990s probably were the most ‘captured’ gatekeepers, despite intense competition.” see Coffee, supra note 13, at 82. But Conyon held that “the market for executive compensation services is a structural oligopoly”, see Conyon, supra note 1, at 410.
34 Also see Lucian Arye Bebchuk & Jesse M. Fried, Executive Compensation as an Agency Problem, 17 J. ECON.
PERSP. 71, 78–79 (2003) (“Providing advice that hurts the CEO’s pocketbook is hardly a way to enhance the consultant’s chances of being hired in the future by this firm or, indeed, by any other firms” ).
35 Conyon, supra note 1, at 410.
36 Testimony of Professor John C. Coffee, Jr., The Role and Impact of Credit Rating Agencies on the Subprime Credit Markets, at 4 (Before the Senate Banking Committee On September 26, 2007), available at http://www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=d1c0419e -d84a-4b43-b02d-4e246e2dbec7.
37 Conyon, supra note 1, at 410-411.
38 Coffee, supra note 3, at 333.
studies offer different findings.39 The reason maybe “the retention of the consultant is endogenous, and missing explanatory variables may plague model estimation.”40 But, at least, the different findings of these studies show the potential harms that the conflicts of interest faced by a compensation consultant may bring to shareholders.
What a pity thing is that there is no empirical studies on the conflicts of interest problem of compensation consultant in China. But, in my opinion, the findings made by foreign scholars may also apply in China. Facing the same conflicts of interest, from my point of view, a compensation consultant (including its employees) will react in similar way. Besides, the Chinese compensation consultants are under more cruel competition and less possibilities of shame sanctions and litigation than their foreign counterparts, so it may be more difficult for them not to favor executives.
1. The influence of cross-selling problem
Using a unique data set of compensation consultant service fee in US S&P 500 firms in 2009, Wei Cen and Na Qiong Tong found that “CEO salary, bonus and total compensation are higher in firms where the consultants provide other service and that pay is higher when the fees paid to consultants for other services are larger.”41 Besides, according to Murphy and Sandino, “in both the US and Canada that CEO pay is higher in companies where the consultant provides other services, and that pay is higher in Canadian firms when the fees paid to consultants for other services are large relative to the fees for executive-compensation services.”42
2. The influence of repeat-business problem
The influence of repeat-business problem can be observed by the following method:
if a compensation consultant is changed, whether the level or structure of executives’
compensation will become more favorable to them. If so, repeat-business will cripple the independence of a compensation consultant. The reason is that a compensation consultant can anticipate that if it recommends less favorable compensation, it may lose the chance of being hired again. In order to maintain its relationship with the
39 Bender analyzed 11 research studies and concluded different findings, see Bender, supra note 4, at 20-22.
40 Conyon, supra note 1, at 424.
41 Wei Cen & Na Qiong Tong, Compensation Consultant Independence and CEO Pay (January 5, 2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1735506.
42 Kevin J. Murphy & Tatiana Sandino, Executive Pay and “Independent” Compensation Consultants, 49 Journal of Accounting and Economics 247, 248 (2010). Surely, there are existing different findings of the influence of crossing-selling problem. For example, according to Conyon, “there is little evidence that consultants with potential conflicts of interest, such as supplying other business to client firms, leads to greater CEO pay or the adverse design of pay contracts.” see Martin J. Conyon, Compensation Consultants and Executive Pay:
Evidence from the United States and the United Kingdom, (May 2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1106729. But, in his paper, “Executive Compensation Consultants and CEO Pay”, Conyon held the different opinion, Conyon, supra note 1, at 424 (“CEO pay is higher in firms where the consultant supplies other business services, or where management is involved in the selection of the compensation consultant.”).
company, it is better for it to recommend favorable compensation to executives. Using a sample of FTSE 350 firms in UK from 2002 to 2008, Goh and Gupta found that
“executives of firms that switch their main consultant receive higher salary increments in the year of the switch (both absolute and adjusted for median peer levels) and a less risky compensation package, through a higher proportion of bonus and a lower proportion of equity pay. The results provide some evidence that companies successfully engage in opinion-shopping between consultants for more favorable compensation packages for executives.”43 But, by examining whether CEO pay is related to a proxy for managerial influence over the decision to appoint (or reappoint) consultants, i.e. an indicator of whether the consultant work ed exclusively for the committee or also worked for management, Murphy and Sandino found that
“CEO pay is actually about 13% higher in US companies where the consultant works exclusively for the compensation committee rather than for management. The lack of support for the repeat business hypothesis is robust to a variety of specifications, including a propensity-score matching approach that mitigated the endogeneity of the board’s choice to retain its own consultant.”44 “One interpretation of the data is that pay consultants recommend greater pay-at-risk for the CEOs of client firms, reflecting greater pay-for-performance. ...Risk-averse CEOs whose contracts contain more risky compensation such as stock options will demand greater levels of pay.”45
III. How Compensation Consultants Are Regulated in the US
It is clear that only self-discipline and market competition is not enough to address the conflicts of interest problem faced by a compensation consultant. So, laws and rules can play a critical role in addressing this problem. This part, first, briefly introduces how compensation consultants resolve the conflicts of interest problem in the way of self-discipline; second, analyzes how the Dodd-Frank Wall Street Reform Act of 2010 (Dodd-Frank Act) addresses this problem ex ante; third, shortly discusses how to reform compensation consultant’s civil liabilities ex post based on Coffee and Partnoy’s suggestions.
43 Lisa Goh & Aditi Gupta, Executive Compensation, Compensation Consultants, and Shopping for Opinion:
Evidence from the United Kingdom, 25 Journal of Accounting, Auditing & Finance 607 (2010) . 44 Murphy & Sandino, supra note 42, at 248.
45 See Conyon, supra note 1, at 410.
A. How a compensation consultant addresses the conflicts of interest problem