Conflicts of Interest Drive CEO Pay Sky High

Last week the Corporate Library reported that Chief Executive Officer (CEO) compensation tripled from 1990 to 2004. As a result, in 2005, the average CEO in the United States earned 262 times the pay of the average worker, the second-highest level of this ratio in the 40 years for which there are data.

A few days before the Detroit Free Press had announced that U. S. auto companies CEOs' pay rose 22% last year despite the fact that two-thirds of the companies were losing money and all were losing market share. The pay raises came as Ford, GM and Chrysler are preparing for contract talks with the United Auto workers. It is widely anticipated that these corporations,which are all losing money and laying off employees in North America, will ask their employees for wage and benefit concessions in the next round of bargaining.

Apologists argue that CEO compensation is set by the laws of supply and demand.

But it turns out there is nothing invisible about the hand setting CEO salaries.

Their lavish pay is set by their CEO brethren with the assistance of executive compensation consultants.

It's conflict enough that compensation committees are composed of fellow CEOs. After all corporations benchmark against each other. These directors know if they reward their fellow CEO handsomely, it will establish a baseline for their own pay. In an early blog I characterized this as "the race to the top."

Compounding the problem is that as executive pay has soared, compensation committees have turned to "independent" consultants to help them determine and legitimize executive compensation.

But the consultants charged with advising on compensation are often employed by large companies providing other even more lucrative services — like actuarial work on company pensions and the outsourcing of employee benefit programs — to those same corporations.

Can anyone spell conflict of interest?

These conflicts among pay consultants are reminiscent of those in the late 1990s among accounting firms, like Arthur Andersen, that provided lucrative consulting services related to information technology and tax issues for the same companies whose financial results they were charged with certifying. The result was a rash of corporate scandals as consulting firms ignored financial mismanagement to maintain their more profitable contracts.

After the S.E.C. required companies to disclose what they were paying in consulting as well as audit fees, the industry moved to separate the two businesses, but not before firms like Enron and Worldcom imploded, losing billions in stockholder value. Thousands of employees lost
their jobs and life savings as well.

In overhauling its disclosure rules on executive pay last year, the S.E.C. did not require companies to disclose details that would signal potential conflicts among consultants, like the type of other work done by compensation consultants or the revenues earned under those arrangements.

So now Congressmen Henry Waxman, chair of the House Committee on Oversight and Government Reform, has initiated an investigation into potential conflicts of interest among compensation consulting firms that do other lucrative work while helping establishing the very same firms executive pay.

Good for Congressman Waxman!

What his investigation will disclose is that interlocking and symbiotic relationship between consulting firms, compensation committees and CEOs is the visible hand that is driving CEO compensation into the stratosphere!