A few weeks ago I was invited to attend a meeting of a company’s board of directors. One of the topics of discussion at this meeting was compensation for members of the board. The chairman of the Compensation Committee came in and reported that after extensive analysis and input from an “independent compensation consultant,” his committee was recommending a 35 percent increase in compensation for the board.
Of course, the level of corporate board compensation is set much the same as a “fox guarding the henhouse” way that pay for Congress is established. Those who are to receive the pay – directors and members of Congress – are the very ones who determine what their own pay should be.
Not surprisingly, something is not quite right with that system—even though there are some checks and balances. For example, voters can refuse to reelect members of Congress who give themselves excessive raises in the same way that shareholders can oust a board if they feel directors have been unreasonable in matters of compensation. The problem is there is still room for “creeping” abuse, especially for those companies that employ outside management compensation consultants.
In the meeting I attended, a heated discussion followed the presentation of the Compensation Committee. The chairman was grilled as to the logic of the recommendation. Like Colin Powell’s single United Nations argument justifying war against Iraq was based on the “disclosure” that Iraq was developing “weapons of mass destruction,” the chairman based the justification of the recommendation for increased compensation on “disclosure” by a management consultant that the company was falling behind the compensation paid by other companies.
Herein lurks another deep-seated problem with using management consultants and why they all should all be bundled together as fire wood. This consultant had marched into the Compensation Committee with all types of neatly prepared charts, graphs and peer group comparisons. And yes, they did seem to show that board compensation for this company had fallen below what others were paying.
But, that is the problem. Let’s say this board had followed the recommendations of this management consultant (which, to their credit they did not) and increased board compensation by 35 percent. That action then becomes public record and the increase is factored into the charts and graphs of all the other management consultants. This action increases a new “norm,” and that creates a “merry-go-round” effect, so that by the next time around, the other companies have increased their compensation to match the other peers and the company has fallen behind again. How stupid is that? In effect you have the blind leading the deaf! It should be noted that this is not an issue at just the board of director level. Many companies retain management consultants to determine and recommend compensation at all levels. And, this compounds the problem.
While this approach does create continuing work for management consultants and provides companies with a shield for their actions, i.e. “We really didn’t want to increase the pay, but we have to keep pace with our peers or else we will not be able to retain or attract directors.” Hogwash! Maybe “merry-go-round effect” is too mild a term to use – maybe to describe it as a “circle-jerk” would be more appropriate. It’s the worst kind of “keeping up with the Joneses” that business can invite upon itself.
Compensation – at all levels of an organization – is one of the most important and critical responsibilities of management. Compensation is a powerful tool – for good and bad – that constantly sends signals to all levels of an organization. For example, if the directors of this company had accepted the recommendation of a 35 percent increase, while all other employees of the organization were given an average increase of three percent – what type of signal would that have sent to those line employees? The consultant will never worry about this type of message, but management should.
Sure, some will argue that retaining outside “experts” to develop compensation plans gives them access to information and experience they would not otherwise have available to them. Poppycock! First of all, who cares about what other companies are doing? Who knows if they are doing the right thing? After all, they are probably using the same consultants. Besides, in today’s world, a simple Google search will offer access to the same information the consultant will charge thousands of dollars for.
And the Moral of the Story …
Compensation – like most other things a company does – is too important to leave to outside consultants. It is the responsibility of management to understand and determine appropriate levels of compensation. It should never be based on what “other people” think a given job should be worth, but on what people bring to the job and the value they add. No outside management consultant can ever understand this concept. And, they just keep going round and round.