Compensation consultants are now becoming a popular tool to assist company in managing their compensation program and corporate governance strategies. However, there are both pros and cons in using compensation consultants. On one hand, there are some clear benefits; firstly, compensation consultants can provide expert knowledge, for example, insight and advice on trends in executive compensation, an assessment of executive compensation relative to executive performance; and insight and advice on the level and mix of pay and benefits (Conyon, 2007).
Although, compensation consultants are viewed as external third parties providing solutions of optimal efficient managerial compensation contracts to align the benefits of both the employee and employer in the most fair and unbiased way. They have the ability to help the firm maximize shareholder’s value by designing compensation schemes that more closely align the interests of managers with shareholders since they can bring breadth and depth of experienced from handling similar problems and benchmarking comparable (peer group) firms especially when there is high information asymmetry between different parties.
Other benefits include cost reduction in recruiting/rewarding process and efficient allocation of resources by taking the tasks away from human resource, compensation committee and shareholders who may not have the knowledge and experience in determining senior executive pay package. On the other hand, there are some drawbacks in hiring compensation consultants. Firstly, compensation consultants face potential conflicts of interest that can lead to higher recommended levels of CEO pay, including the desires to cross-sell services and to secure repeat business.
Evidence shows that US CEOs receive about 18% more total compensation, and Canadian CEOs receive about 33% more, when their executive compensation consultant also provides other services to the firm (Murphy & Sandino, 2010). They are more likely to help executives by pushing for higher compensations in hope of being rewarded with more consultants services with the company as such firms that hire compensation consultants are more likely to have higher CEO compensation levels than those that have not hired a consultant (Voulgaris, et al. 2010) (Goh & Gupta, 2010).
However, contrary to the study of Murphy & Sandino 2010, some scholars found that the potential conflict of interest between the firm and consultant is not a primary driver of excessive CEO pay. Their explanation is that opposing incentives to maintain consultants’ credibility or safeguards put in place by compensation committees limit actions taken with regard to cross-selling incentives (Cadman, et al. , 2010).
Secondly, consultant fees can be substantial; thus, the company should weigh the costs/benefits to determine whether hiring a consultant is appropriate. Thus, in my view, compensation consultants may not be part of agency problems but rather a solution to the problem of designing an optimal executive pay contract that aligns the interests of both the employee and employer if the firm can strengthen and promote transparency in its hiring process to maximize shareholder’s values.
Courtney from Study Moose
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