Skip to main content

Advertisement

SpringerLink
Log in

New perspectives on the governance of executive compensation: an examination of the role and effect of compensation consultants

  • Published:
Journal of Management & Governance Aims and scope Submit manuscript

Abstract

We develop a multi-theoretic approach, drawing on economic, institutional, managerial power and social comparison literatures to explain the role of the external compensation consultant in the top management pay setting institutional field. Taking advantage of recent disclosure requirements in the UK, we collect data on compensation consultant use in 232 large companies. We show that consultants are a prevalent part of the CEO pay setting scene, and document evidence of all advisor use. Our econometric results show that consultant use is associated with firm size and the equity pay mix. We also show that CEO pay is positively associated with peer firms that share consultants, with higher board and consultant interlocks, and some evidence that where firms supply other business services to the firm, CEO pay is greater.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. See http://www.towersperrin.com/hrservices/uk/default_uk.htm.

  2. In separate analysis, we investigated the pure ‘compensation consultant’ effect on pay, namely whether pay was greater in firms with consultants than in those where boards did not consult them. We were unable to isolate a consistent effect on pay, and results were sensitive to econometric methods used.

  3. In the US, the case of Michael Ovitz’s $140 million severance package at Walt Disney is instructive. In litigation, shareholders were ultimately unable to demonstrate that the compensation plan was egregious. In addition, the case lasted 8 years illustrating the complexities involved.

  4. Of course, this does not exclude the possibility that members of the compensation committee themselves are beholden to the CEO, and thus the consultant is under the CEO’s indirect influence.

  5. Indeed, as Bebchuk and Fried (2004, p. 38) remark: “A tilt in favor of executives on the part of compensation consultants could produce outcomes favorable to executives even if directors themselves had no incentives and tendencies to favor executives.” This suggests that even if measures of CEO-Board power that have been used in the literature suggest that boards are not a passive tool of management interests (Vance 1983), failure to account for consultant incentives may omit important explanatory factors.

  6. Our paper complements other corporate governance papers with an international focus. For example, see Werder et al. (2005), Tosi and Greckhamer (2004), Thomsen and Pedersen (2000), Eriksson (2000) and Conyon and Murphy (2000).

  7. The total market capitalization of firms with UK origin on the London Stock Exchange in January 2006 was ₤1,867,400 million. The sum of the largest 100 firms was ₤1,477,889 million and the sum of the largest 250 firms was 1,684,791 million. These represent about 79 and 90% of market capitalization respectively.

  8. In the US, restricted stock and option grants typically vest with the passage of time (but not with performance criteria). In the UK, by contrast the vesting of restricted stock and options is typically tied to the attainment of certain performance objectives.

  9. It is well known that the value of a European call option on a dividend paying stock is c = Se−qtN(d1) − Xe−rtN(d2), where d1 = {ln(S/X) + (r − q + σ2/2)t}/σ√t, d2 = d1 − σ√t, and S is the stock price; X the exercise price; t the maturity term; r the risk-free interest rate; q the dividend yield and σ the volatility of returns. N(·) is the cumulative probability distribution function for a standardized normal variable.

  10. The analysis presented here uses the mean of other firms; similar results are obtained if one used the median.

  11. Towers Perrin began life in 1934 as Towers, Perrin, Forster and Crosby in Philadelphia with a Reinsurance Division and a Life Division. It now contains a global executive compensation service as part of its business. New Bridge Street Consultants are an executive pay consulting spin-off the large UK-based law firm Clifford Chance and internationally are linked with US firm Frederick W. Cook and Co. Inc.

  12. Sometimes the fees and compensation received for these other services can be considerable. British Sky Broadcasting Group Plc stated that “The Group uses the services of Deloitte and Touche LLP Executive Compensation Consulting, who replaced Arthur Andersen in providing advice to the Committee. Deloitte and Touche has been appointed by the Group and provide advice as required by the Committee. Deloitte and Touche also acts as the Group’s auditors, and provide other services to the Group as detailed in Note 7 to the financial statements.” Note 7 to the financial statements reads: “In addition to the amounts noted above, the Group understands that during the year its auditors indirectly received from the Group a further 4 million through the performance of sub-contracted services for one of the Groups call centre consultants”.

  13. In separate analysis, we examined the effect of using more than one consultant, namely using the number of consultants used in our pay models. We found no evidence that the pure number of consultants had an effect on pay.

  14. The models in Table 6 are estimated for the restricted sample of those firms that have consultants (n = 206). The significant effect of the consultants having other business is not significant on the full sample described. We suggest this result (of this pay premium) is not particularly robust to alternative specifications and worthy of further research.

  15. Warren Buffett and Charles Munger at Berkshire Hathaway have been critical of the process of how CEO pay is set at major corporations: Mr. Buffet said: “The typical large company has a compensation committee … They don’t look for Dobermans on that committee, they look for Chihuahuas … Chihuahuas that have been sedated”. Mr. Munger added: “I would rather throw a viper down my shirtfront than hire a compensation consultant.” http://money.cnn.com/2004/05/03/pf/buffett_qanda/index.htm. The New York Times (4/10/2006) noted that “Because of what goes on in compensation consulting stays in the hushed confines of corporate boardrooms, the roles of these advisers in determining executive pay have been hidden from investor’s view … the conflicts bedeviling some of the large consulting firms help explain why in good times or bad, executive pay in America reaches dizzying heights each year”.

  16. Interestingly, the company did not continue to provide such details of financial compensation for its executive compensation advisors in it 2005 Annual Report and Accounts.

  17. New York Times 4/10/2006 “Advice on Boss’s pay may not be so independent”.

  18. Failure to vote on the remuneration report can, however, result in significant fines for directors.

  19. We are grateful to the reviewer for making this observation.

  20. The UK legislation means the data is not available pre-2003. The use of consultants is likely to be persistent over short periods of time so we suspect only a few changes would have happened to date. In addition, recall that the additional necessary compensation data is extremely difficult to assemble in the UK since currently it must be collected by hand. Hence, here we present cross-sectional evidence as the first step to understanding the role of pay consultants.

  21. Another interesting approach to this issue would be to examine how a compensation consultants’s US experience or international operations may lead to an upward homogenization of pay. We are grateful to the reviewer for this observation.

References

  • 3i Group Plc. (2004). Annual report and accounts.

  • Abrahamson, E., & Rosenkopf, L. (1993). Institutional and competitive bandwagons: Using mathematical modeling as a tool to explore innovation diffusion. Academy of Management Review, 18, 487–517.

    Article  Google Scholar 

  • Baker, G. P., Jensen, M. C., & Murphy, K. J. (1988). Compensation and incentives—practice vs theory. Journal of Finance, 43(3), 593–616.

    Article  Google Scholar 

  • Bebchuk, L. A., & Fried, J. (2003). Executive compensation as an agency problem. Journal of Economic Perspectives, 17, 71–92.

    Article  Google Scholar 

  • Bebchuk, L. A., & Fried, J. (2004). Pay without performance: The unfulfilled promise of executive compensation. Cambridge, MA: Harvard University Press.

    Google Scholar 

  • Bizjak, J. M., Lemmon, M. L., Naveen, L. (2000). Has the use of peer groups contributed to higher levels of executive compensation? Accessed November 15, 2000 from http://ssrn.com/abstract=252544.

  • Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81, 637–654.

    Article  Google Scholar 

  • Boyd, B. K. (1994). Board control and CEO compensation. Strategic Management Journal, 15, 335–344.

    Article  Google Scholar 

  • Conyon, M. J., & Murphy, K. (2000). The prince and the pauper: Executive compensation in the US and UK. Economic Journal, 110, 640–671.

    Article  Google Scholar 

  • Conyon, M. J., & Peck, S. I. (1998). Board control, remuneration committees and top management compensation. Academy of Management Journal, 41, 146–157.

    Article  Google Scholar 

  • Core, J., Holthausen, R., & Larcker, D. (1999). Corporate governance, chief executive officer compensation and firm performance. Journal of Financial Economics, 51, 371–406.

    Article  Google Scholar 

  • Crystal, G. (1991). Why is CEO compensation so high? California Management Review, 34, 9–29.

    Google Scholar 

  • Dacin, M. T. (1997). Isomorphism in context: The power and prescription of institutional norms. Academy of Management Journal, 40, 46–81.

    Article  Google Scholar 

  • Dacin, M. T., Goodstein, J., & Scott, R. W. (2002). Institutional theory and institutional change: Introduction to the special research forum. Academy of Management Journal, 45(1), 45–57.

    Article  Google Scholar 

  • Daily, C. M., Johnson, J. L., Ellstrand, A. E., & Dalton, D. R. (1998). Compensation committee composition as a determinant of CEO compensation. Academy of Management Journal, 41, 209–220.

    Article  Google Scholar 

  • Davis, G. F., & Greve, H. R. (1997). Corporate elite networks and governance changes in the 1980s. American Journal of Sociology, 103, 1–37.

    Article  Google Scholar 

  • Davis, G. F., & Stout, S. K. (1992). Organization theory and the market for corporate control: A dynamic analysis of the characteristics of large takeover target, 1980–1990. Administrative Science Quarterly, 37, 605–633.

    Article  Google Scholar 

  • Deutsch, Y. (2005). The impact of board composition on firms’ critical decisions: A meta-analytic review. Journal of Management, 31, 424–444.

    Google Scholar 

  • Devers, C. E., Cannella, A. A., Reilly, G. P., & Yoder, M. E. (2007). Executive compensation: A multi-disciplinary review of recent developments. Journal of Management, 33(6), 1016–1072.

    Article  Google Scholar 

  • DiMaggio, P., & Powell, W. W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48, 147–160.

    Article  Google Scholar 

  • Dixons Group. (2004). Annual report and accounts.

  • Dobbin, F. R., Edelman, L., Meyer, J. W., Scott, R. W., & Swindler, A. (1988). The expansion of due process in organizations. In L. G. Zucker (Ed.), Institutional patterns and organizations: Culture and environment. Cambridge, MA: Ballinger.

    Google Scholar 

  • Dobbin, F. R., & Sutton, J. R. (1998). The strength of a weak state: The rights revolution and the rise of human resource management divisions. American Journal of Sociology, 97, 1531–1576.

    Google Scholar 

  • Eriksson, T. (2000). What determines managers pay? Long Range Planning, 33, 544–559.

    Article  Google Scholar 

  • Festinger, L. (1954). A theory of social comparison processes. Human Relations, 7, 114–140.

    Google Scholar 

  • Finkelstein, S., & Boyd, B. (1998). How much does the CEO matter? The role of managerial discretion in the setting of CEO pay. Academy Management Journal, 41, 179–199.

    Article  Google Scholar 

  • Finkelstein, S., & Hambrick, D. C. (1996). Strategic leadership: Top executives and their effects on organizations. St Paul: West.

    Google Scholar 

  • Fligstein, N. (1990). The transformation of corporate control. Cambridge, MA: Harvard University Press.

    Google Scholar 

  • Gomez-Mejia, L. R. (1994). Executive compensation: A review and integration of the literature. In G. R. Ferris (Ed.), Research in personnel and human resource management (Vol. 12, pp. 161–222). Greenwich, CT: JAI Press.

    Google Scholar 

  • Greenbury, R. (1995). Directors remuneration: Report of a study group chaired by Sir Richard Greenbury. London: Gee.

    Google Scholar 

  • Greenwood, R., & Hinings, C. R. (1996). Understanding radical organizational change: Bringing together the old and the new institutionalism. Academy of Management Review, 21, 1022–1054.

    Article  Google Scholar 

  • Greenwood, R., Suddaby, R., & Hinings, C. R. (2002). Theorizing change: The role of professional associations in the transformation of institutionalized fields. Academy of Management Journal, 45, 58–80.

    Article  Google Scholar 

  • Hambrick, D., & Finkelstein, S. (1987). Managerial discretion: A bridge between polar views of organizations. In L. L. Cummings & B. M. Staw (Eds.), Research in organizational behavior (Vol. 9, pp. 369–406). Greenwich, CT: JAI Press.

    Google Scholar 

  • Haunschild, P. R., & Beckman, C. M. (1998). When do interlocks matter?: Alternate sources of information and interlock influence. Administrative Science Quarterly, 43, 815–844.

    Article  Google Scholar 

  • Haunschild, P. R., & Miner, A. S. (1997). Modes of inter-organizational imitation: The effects of outcome salience and uncertainty. Administrative Science Quarterly, 43, 815–844.

    Article  Google Scholar 

  • Jensen, M. C., & Murphy, K. J. (1990). Performance pay and top-management incentives. Journal of Political Economy, 98(2), 225–264.

    Article  Google Scholar 

  • Kraatz, M. S. (1998). Learning by association? Interorganizational networks and adaptation to environmental change. Academy of Management Journal, 41, 621–643.

    Article  Google Scholar 

  • Kraatz, M. S., & Zajac, E. J. (1996). Exploring the limits of new institutionalism: The causes and consequences of illegitimate organizational change. American Sociological Review, 61, 812–836.

    Article  Google Scholar 

  • Marris, R. L. (1964). The economic theory of managerial capitalism. London: Macmillan.

    Google Scholar 

  • Meyer, J. W., & Rowan, B. (1977). Institutionalized organizations: Formal structure as myth and ceremony. American Journal of Sociology, 83, 340–363.

    Article  Google Scholar 

  • Miner, A. S., & Haunschild, P. R. (1995). Population level learning. In L. L. Cummings & B. M. Shaw (Eds.), Research in organizational behavior (Vol. 17, pp. 115–166). Greenwich, CT: JAI Press.

    Google Scholar 

  • Murphy, K. J. (1999). Executive compensation. In O. Ashenfelter & D. Card (Eds.), Handbook of labor economics (Vol. 3). Amsterdam: North Holland.

    Google Scholar 

  • Newman, M. E. (2003). The structure and function of complex networks. SIAM Review, 45, 167–256.

    Article  Google Scholar 

  • North, D. (1990). Institutions, institutional change and economic performance. Cambridge: Cambridge University Press.

    Google Scholar 

  • Ocasio, W. (1994). Political dynamics and the circulation of power: CEO succession in US industrial corporations 1960–1990. Administrative Science Quarterly, 31, 586–611.

    Google Scholar 

  • Oliver, C. (1997). The influence of institutional and task environment relationships on organizational performance: The Canadian construction industry. Journal of Management Studies, 34, 99–124.

    Article  Google Scholar 

  • O’Reilly, C. A., Main, B., & Crystal, G. S. (1988). CEO compensation as tournament and social comparison: A tale of two theories. Administrative Science Quarterly, 33, 257–274.

    Article  Google Scholar 

  • Ornstein, M. D. (1984). Interlocking directorates in Canada: Intercorporate alliance or class alliance? Administrative Science Quarterly, 29, 210–231.

    Article  Google Scholar 

  • Palmer, D. A., Jennings, P. D., & Zhou, X. (1993). Late adoption of the multi-divisional form by large US corporations: Institutional, political and economic accounts. Administrative Science Quarterly, 38, 100–131.

    Article  Google Scholar 

  • Pfeffer, J. (1992). Managing with power: Politics and influence in organizations. Cambridge, MA: Harvard University Press.

    Google Scholar 

  • Pfeffer, J., & Salancik, G. R. (1978). The external control of organizations: A resource dependence perspective. New York: Harper and Row.

    Google Scholar 

  • Rao, H., Davis, G. F., & Ward, A. (2000). Embeddedness, social identity, and mobility: Why firms leave the NASDAQ and join the New York stock exchange. Administrative Science Quarterly, 45, 268–292.

    Article  Google Scholar 

  • Ruef, M., & Scott, W. R. (1998). A multi-divisional model of organizational legitimacy: Hospital survival in changing institutional environments. Administrative Science Quarterly, 43, 877–904.

    Article  Google Scholar 

  • Scott, R. W. (1994). Institutions and organizations: Toward a theoretical synthesis. In R. W. Scott & J. W. Meyer (Eds.), Institutional environments and organizations: Structural complexity and individualism. Thousand Oaks, CA: Sage.

    Google Scholar 

  • Scott, R. W. (2001). Institutions and organizations (2nd ed.). Thousand Oaks, CA: Sage.

    Google Scholar 

  • Selznick, P. (1992). The moral commonwealth. Berkeley: University of California Press.

    Google Scholar 

  • Sherer, P. D., & Lee, K. (2002). Institutional change in large law firms: A resource dependency perspective. Academy of Management Journal, 45, 102–142.

    Article  Google Scholar 

  • Suchman, M. C. (1995). Managing legitimacy: Strategic and institutional approaches. Academy of Management Review, 20, 571–610.

    Article  Google Scholar 

  • Thomsen, S., & Pedersen, T. (2000). Ownership structure and economic performance in the largest European companies. Strategic Management Journal, 21, 689–705.

    Article  Google Scholar 

  • Tolbert, P. S., & Zucker, L. G. (1983). Institutional sources of change in the formal structure of organizations: Diffusion of civil service reform 1880–1935. Administrative Science Quarterly, 28, 22–39.

    Article  Google Scholar 

  • Tolbert, P. S., & Zucker, L. G. (1996). Institutionalization of institutional theory. In S. Clegg, C. Hardy, & W. Nord (Eds.), The handbook of organization studies (pp. 175–190). Thousand Oaks, CA: Sage.

    Google Scholar 

  • Tosi, H., & Gomez-Mejia, L. (1989). The decoupling of CEO pay and performance: An agency theory perspective. Administrative Science Quarterly, 34, 169–189.

    Article  Google Scholar 

  • Tosi, H., & Greckhamer, T. (2004). Culture and CEO compensation. Organization Science, 15, 657–670.

    Article  Google Scholar 

  • Tversky, A., & Kahneman, D. (1974). Judgment and uncertainty: Heuristics and biases. Science, 185, 1124–1131.

    Article  Google Scholar 

  • Useem, M. (1984). Inner circle: Large corporations and the rise of business political activity in the US and UK. New York: Oxford University Press.

    Google Scholar 

  • Uzzi, B. D. (1996). The sources and consequences of embeddedness for the economic performance of organizations: The network effect. American Sociological Review, 61, 674–698.

    Article  Google Scholar 

  • Vance, S. C. (1983). Corporate leadership: Boards, directors and strategy. New York: McGraw-Hill.

    Google Scholar 

  • Wade, J. B., O’Reilly, C. A., & Pollock, T. G. (2006). Overpaid CEOs and underpaid managers: Fairness and executive compensation. Organizational Science, 17(5), 527–544.

    Article  Google Scholar 

  • Wade, J. B., Porac, J. F., & Pollock, T. G. (1997). Worth, words and the justification of executive pay. Journal of Organizational Behavior, 18, 641–664.

    Article  Google Scholar 

  • Wasserman, S., & Faust, K. (1994). Social network analysis. Cambridge: Cambridge University Press.

    Google Scholar 

  • Watts, D. J. (2004). The “new” science of networks. Annual Review of Sociology, 30, 243–270.

    Article  Google Scholar 

  • Werder, A., Talaulicar, T., & Kolat, G. (2005). Compliance with the German corporate governance code: An empirical analysis of the compliance statements by German listed companies. Corporate Governance: An International Review, 13, 178–187.

    Article  Google Scholar 

  • Westphal, J. D., & Zajac, E. J. (1994). Substance and symbolism in CEO’s long-term incentive plans. Administrative Science Quarterly, 39, 389–402.

    Article  Google Scholar 

  • Zajac, E. J. (1988). Interlocking directorates as an interorganizational strategy: A test of critical assumptions. Academy of Management Journal, 31, 428–438.

    Article  Google Scholar 

  • Zajac, E. J. (1990). CEO selection, succession, compensation and firm performance: A theoretical integration and empirical analysis. Strategic Management Journal, 11, 217–230.

    Article  Google Scholar 

  • Zajac, E. J., & Westphal, J. D. (1995). Accounting for explanations of CEO compensation: Substance and symbolism. Administrative Science Quarterly, 40, 283–308.

    Article  Google Scholar 

  • Zucker, L. G. (1977). The role of institutionalization in cultural persistence. American Sociological Review, 42, 726–743.

    Article  Google Scholar 

Download references

Acknowledgments

We would like to thank seminar participants at the Journal of Management and Governance symposium, Naples, the discussant Sven Collin, the editors of the special issue, Robert Hoskisson, Morten Huse, Riccardo Vigano and Alessandro Zattoni and the anonymous reviewers. We would also like to thank Lucian Bebchuk, Matthew Bidwell, Peter Cappelli, Jay Chok, Gina Dokko, Daniel Forbes, Rob Grant, Lerong He, Sheen Levine, Henry Tosi and Chloe Wayne as well as seminar participants at Case Western Reserve University, Georgetown University, Instituto de Empresa, Singapore Management University, the Wharton School and the Academy of Management Meetings in Atlanta for comments on earlier versions of this paper. We are also grateful to practitioner colleagues at Mercer Human Resource Consulting, Towers Perrin and Watson Wyatt for their advice in the preparation of this paper. The views expressed here are solely those of the authors.

Author information

Authors and Affiliations

  1. ESSEC Business School, Paris, France

    Martin J. Conyon

  2. Weatherhead School of Management, Case Western Reserve University, 10900 Euclid Avenue, Cleveland, OH, 44106-7235, USA

    Simon I. Peck

  3. Aston University, Birmingham, UK

    Graham V. Sadler

Authors
  1. Martin J. Conyon
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Simon I. Peck
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Graham V. Sadler
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Simon I. Peck.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Conyon, M.J., Peck, S.I. & Sadler, G.V. New perspectives on the governance of executive compensation: an examination of the role and effect of compensation consultants. J Manag Gov 15, 29–58 (2011). https://doi.org/10.1007/s10997-009-9117-6

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10997-009-9117-6

Keywords

Search

Navigation