Why CEOs Get Paid the Big Bucks

The New York Times takes a good, hard look at one of the hidden factors behind the continuing increase in executive compensation.

Not long ago, in an interview with the Wall Street Journal, Treasury Secretary John Snow took a stab at explaining the recent astronomical rise in CEO compensation. Snow, a former well-compensated CEO himself, credited soaring executive salaries and benefits to the machinations of the free market acting freely.

“In an aggregate sense, it reflects the marginal productivity of CEOs,” Snow told the Journal. “Do I trust the market for CEOs to work efficiently? Yes. Until we can find a better way to compensate CEOs, I’m going to trust the marketplace.”

But according to an insightful article Monday in the New York Times, many corporate leaders appear to be benefiting not only from the invisible hand of the free market but also from the invisible hands of so-called independent “compensation consultants” — a group of advisers who, according to the Times, are often anything but independent.

In the Times article, entitled “Advice on Boss’s Pay May Not Be So Independent,” writer Gretchen Morgenson successfully pins down the role that compensation consultants have played in escalating CEO compensation.

“This is the secretive, prosperous and often conflicted world of compensation consultants, who are charged with helping corporate boards determine executive pay that is appropriate and fair, and who are often cited as the unbiased advisers whenever shareholders criticize a company’s pay as excessive,” writes the Times.

“Because much 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 investors’ view,” adds the Times. “Nevertheless, corporate governance experts say, 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.”

As a convincing example, the Times gives us the case of Ivan G. Seidenberg, chief executive of Verizon Communications. Last year was not a particularly good one for Verizon. The company’s stock price was down, as were its earnings. Nevertheless, Seidenberg’s compensation, which was supposedly tied to the performance of the company, skyrocketed, including “$19.4 million in salary, bonus, restricted stock and other compensation, 48 percent more than in the previous year.”

What gives?

As the Times notes, Seidenberg’s net worth received a significant boost thanks, in part, to the recommendations of an unnamed “outside consultant.” As it turns out, according to the Times, that consultant was Hewitt Associates.

“Hewitt does much more for Verizon than advise it on compensation matters,” reports the Times. “Verizon is one of Hewitt’s biggest customers in the far more profitable businesses of running the company’s employee benefit plans, providing actuarial services to its pension plans and advising it on human resources management. According to a former executive of the firm who declined to be identified out of concern about affecting his business, Hewitt has received more than half a billion dollars in revenue from Verizon and its predecessor companies since 1997.”

That’s not exactly what we would call an “outside” consultant. To use a technical economic term, it seems more like back scratching.

As the Times goes on to note, companies are not currently required to disclose the identities of their compensation consultants to the SEC — a situation that appears ripe for abuse.

“The potential for conflict is reminiscent of that among auditing firms that were performing lucrative consulting services related to information technology and tax issues for the same companies whose financial results they were certifying,” notes the Times. “When the SEC required companies to disclose how much they were paying in consulting as well as audit fees, the industry was compelled to separate these businesses.”

The Times is hardly alone in reporting on the continued, increasing disparity between executive and worker compensation. Elsewhere Monday, for example, both the Wall Street Journal (subscription) and USA Today reported stories on runaway executive compensation.

But whereas other reporters have been left puzzling over the cause of the phenomenon, the Times has succeeded in identifying one of its root factors — one that would benefit from further uprooting.

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Felix Gillette writes about the media for The New York Observer.