Compensation Consultant Independence and CEO Pay

Abstract

Critics allege that executive compensation consultants face potential conflicts of interest (lack of independence) that might lead to higher CEO pay. Conflicts of interest include the desires to "cross-sell" service and to secure "repeat business". Using a unique data set of compensation consultant service fee in U.S. S& P 500 firms in 2009, we find strong evidence that compensation consultant’s conflicts of interest is associated with higher CEO pay. We find that CEO bonus and total compensation are higher in companies where the consultant charges higher compensation-related service fees ("repeat business"). We also find 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 ("cross-sell" service). In particular, evidence shows that that CEO receives 7% more salary, 22.9% more bonus and 15.6% more total compensation in firms where compensation consultants provide other services than that of firms where the consultants do not provide other service. In addition, we also document that CEO’s pay-for-performance-sensitivity (PPS) is lower in firms where the consultants have potential conflicts of interest. In particular, CEO’s PPS over cumulative equity pay (annual equity pay) is 30.12% (256.41%) lower in firms that retain compensation consultant to engage other services than those retain consultants without other services.

Keywords: Executive Compensation, Compensation Consultant, Conflicts of Interest, CEO Pay, board of directors, corporate governance, disclosure

JEL Classification: D23, G32, G38, J33, J44, M14, M52