DATELINE: December 9, 2007, Chicago
Is it more convenient to retain one compensation consulting firm to develop a compensation package for the executive director and handle all the nonprofit's benefit plans? Absolutely, but a new study prepared for Representative Henry A. Waxman, in his capacity as the Chairman of the Committee on Oversight and Government Reform, rather conclusively demonstrates that the nonprofit is likely to end up paying its executive director...
The Desktop Guide is Quickly Becoming the Must Have Guide for Nonprofit Executives
Some of our readers have followed the link to the Amazon.com Web site, but apparently have not bought the Guide. If they were turned off by the price, they should reconsider. One prominent attorney in the exempt organization field grabbed a review copy of the Guide and couldn't put it down. She has instructed a number of her clients to buy it, pointing out to them that for less than 1/2 hour of her billable time, they receive a lesson (and resource) that tells it like she would like it told. If you are starting a new charity, the Guide could save you thousands of dollars in legal fees by teaching you how to better utilize your legal counsel and framing the issues so you don't spin your wheels at $400 an hour. |
considerably more than had the nonprofit used different firms for its executive compensation and benefit planning. Although the study focuses on for-profit publicly-traded entities, there is no reason to believe that its conclusions are not equally applicable to nonprofits. As the old adage goes, "a conflict is a conflict."
The study's findings are not the least bit surprising. The accounting profession has recognized a similar problem. An auditor's independence is called into question if the auditor is performing substantial non-audit services for the audited firm. The Single Audit Act recognizes this problem, as does Section 201 of the Sarbanes-Oxley Act of 2002, which lists nine non-audit services that are deemed to impair an auditor's independence.
Findings: According to the study, in 2006, at least 113 of the Fortune 250 company board's received executive pay advice from consulting firms that were providing other services to the company. What is particularly disturbing is the fact that in many cases, the consulting fees received by the consultants far exceeded the fees that they were paid for rendering executive compensation studies. In addition to benefits work, the other work can include human resource management and actuarial services.
Returning once again to 2006, the consultants providing both executive compensation advice and other services to Fortune 250 companies were paid almost 11 times more for providing other services than they were paid for providing executive compensation advice. On average, the companies paid these consultants over $2.3 million for other services and less than $220,000 for executive compensation advice.
Those numbers raise serious questions regarding the independence of the consultants undertaking dual functions when management retains the consultants for benefits and other consulting work. The consultant acting in dual capacities has a built-in incentive to keep the executive director happy by recommending higher levels for the executive director. This arguably protects the more lucrative benefits and other consulting work, although at least two of the consulting firms in the survey disputed this, arguing that procedures were in place to prevent that from happening.
The report suggests that this is not a theoretical conflict of interest. In 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interest was 67% higher than the median CEO salary of the companies that did not use conflicted consultants. Over the period between 2002 and 2006, the Fortune 250 companies that hired compensation consultants with the largest conflicts increased CEO pay over twice as fast as the companies that did not use conflicted consultants. The report does acknowledge that the numbers are less dramatic when all companies are included, stating,
A similar but less pronounced trend is observed when the CEO salaries of all Fortune 250 companies that used compensation consultants with conflicts of interest are compared to the CEO salaries of Fortune 250 companies that did not use compensation consultants with conflicts of interest. In 2006, the median CEO salary of the companies with conflicted consultants ($8.7 million) was higher than the median CEO salary of the companies that did not use conflicted consultants ($7.5 million).
Methodology. To assess the extent of consultant conflicts of interest, Waxman requested nonpublic information from six leading compensation consultants: Frederick W. Cook & Company, Hewitt Associates, Mercer Human Resources Consulting, Pearl Meyer & Partners, Towers Perrin, and Watson Wyatt. For each consultant, the committee requested data on the value of the executive compensation consulting services and any other services that the consultant provided to Fortune 250 companies from January 1, 2002, through December 31, 2006. The compensation consultants were asked to report as executive compensation consulting fees any revenues earned for work related to the compensation of the most senior executives of the companies, including such services as devising equity compensation plans, designing compensation peer groups, and providing pay survey data. The consultants were asked to report fees earned for services related to compensating employees other than senior executives or for other work unrelated to compensation as "other" revenue.
Four of the consultants (Hewitt, Mercer, Towers Perrin, and Watson Wyatt) reported that they were diversified firms offering a variety of services to their corporate clients. The data received from these four consultants disclosed how much they were paid in each year by each Fortune 250 company to provide executive compensation services and how much they were paid to provide other services for companies for whom the consultants provided both types of services between 2002 and 2006.
Widespread Concern: It is not just Representative Waxman who is concerned about these conflicts. In a recent Pricewaterhouse Coopers study, 67% of the 1,000 directors surveyed said that boards are having trouble controlling CEO pay. See Corporate Board Member and Pricewaterhouse Coopers, What Directors Think: Annual Board of Directors Survey (Oct. 2007). The Conference Board has noted the problem, stating,
When the compensation committee uses information and services from outside consultants, it must ensure that consultants are independent of management and provide objective, neutral advice to the committee. …The economics of the consultants' engagement for services is very important as an insight into independence. Any imbalance in fees generated by management versus fees generated on behalf of the committee should receive intense scrutiny.
See The Conference Board, The Evolving Relationship Between Compensation Committees and Consultants, 6, 15, (Jan. 2006). The Business Roundtable reached a similar conclusion, stating,
[T]he compensation committee should have independent, experienced expertise available to provide advice on executive compensation arrangements and plans. The compensation committee should oversee consultants to ensure that they do not have conflicts that would limit their ability to provide independent advice.
The Business Roundtable, Executive Compensation Principles (2007).
Implications for Nonprofit Boards. The report's findings make a clear case for the board to hire a compensation consulting firm to advise it on executive director compensation that is unaffiliated with the firm advising management on organization-wide compensation and human resource matters. Independence could be viewed as a best practice, but we wonder whether it is better viewed as a requirement given the intermediate sanctions under Section 4958. Specifically, to invoke the rebuttable presumption, the executive must demonstrate that the authorized body setting compensation relied on appropriate data as to comparability. Treasury Regulation Section 53.4958-6(c)(2). To the extent that the data is compiled by a consulting firm, it must be independent. It will be interesting to see whether the Service looks to Representative Waxman's report to challenge the independence of consultanting firms that function in dual capacities when providing services to charities and their boards.
The report also notes that some of some companies are not reporting compensation conflicts as part of the SEC disclosure filings. Obviously that is not a problem for tax-exempt entities, but when the proposed Form 990 is finalized, it will be interesting to see what conflicts its requires to be disclosed. Depending on the wording, tax-exempt entities may be required to make disclosures about their compensation consultants.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good."
Copyright 2007, Charity Governance Consulting LLC. All Rights Reserved. You may not copy any portion of this post to a computer "clipboard" for re-posting anywhere or e-mailing, or otherwise reproduce this post. If you want others to review this post, you may provide them with a link to this web blog. Any use of the material or ideas in this post by reporters or other publishers shall make reference to Jack Siegel, author of "A Guide for Non-Profit Directors, Officers and Advisors: Avoiding Trouble While Doing Good" and this web blog. For additional information call 773-325-2124
