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Monday, April 10, 2006

"Market-Based" Executive Pay

Recently, Treasury Secretary John Snow said that executive pay is set efficiently by the market with the implication being that the compensation executives receive is a fair reward for their productivity according to the assessment of the marketplace. How does this market work? Is it competitive? Here are some details about how executive compensation packages are set. The main points are that the pay is set by compensation committees with the strong influence of outside consultants, and the independence of these committees and consultants is highly questionable. There's more detail in the original article:

Outside Advice on Boss's Pay May Not Be So Independent, by Gretchen  Morgenson, NY Times: ...Ivan G. Seidenberg, chief executive of Verizon Communications, ... received $19.4 million in salary, bonus, restricted stock and other compensation, 48 percent more than in the previous year. Others with a stake in Verizon did not fare so well. Shareholders watched their stock fall 26 percent, bondholders lost value as credit agencies downgraded the company's debt and pensions for 50,000 managers were frozen at year-end. When Verizon closed the books last year, it reported an earnings decline of 5.5 percent.

And yet, according to the committee of Verizon's board that determines his compensation, Mr. Seidenberg earned his pay last year as the company exceeded "challenging" performance benchmarks. Mr. Seidenberg's package was ... devised with the help of an "outside consultant" who reports to the committee.

The independence of this "outside consultant" is open to question. ... Hewitt Associates ... does much more for Verizon than advise it on compensation matters. Verizon is one of Hewitt's biggest customers ... Hewitt has received more than half a billion dollars in revenue from Verizon and its predecessor companies since 1997.

In other words, the very firm that helps Verizon's directors decide what to pay its executives has a long and lucrative relationship with the company, maintained at the behest of the executives whose pay it recommends. ... [C]orporate governance experts say the conflicts [of interest]... help explain why in good times or bad, executive pay in America reaches dizzying heights each year. ...

Any discussion of executive pay quickly leads to compensation consultants, because they are the experts relied upon by company directors ... Directors look to consultants for their knowledge about prevailing pay practices as well as the tax and legal implications of different types of compensation. Yet the consultants' practices have received little scrutiny. ...

Consultant creativity is behind some of the pay practices that have generated huge windfalls for executives in recent years. ... comparisons with what other executives receive is a central factor driving executive pay. ... Consultants are not alone in driving executive pay. Corporate boards are often composed of other chief executives with an interest in keeping executive pay high. ... Verizon's compensation committee, for example, consists entirely of chief executives or former chief executives. Three of the four members sit on other boards with Mr. Seidenberg. ...

The potential for conflicts in consulting arrangements can be difficult for outsiders to spot. Even if the consultant is identified, the other work that a consultant's company performs for the compensation client is hard to plumb. .... The potential for conflict is reminiscent of that among auditing firms that were performing lucrative consulting services ... for the same companies whose financial results they were certifying. ... In many cases, a company's chief executive is present at meetings where the compensation consultant and the human resources executive hash out the terms of a package. ...

Note: I suppose I should divulge that I have consulted for Verizon on assessing the competitiveness of local exchange markets for regulatory proceedings and on other matters (e.g. as in this FCC document on special access prices - see page 22, I am Mark A. Thomas, not Thoma, due to a typo) so my independence is open to question. I've shied away from writing about telecommunications issues for this reason.

    Posted by on Monday, April 10, 2006 at 09:12 AM in Economics, Income Distribution, Market Failure | Permalink  TrackBack (0)  Comments (6)

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