Interesting Article: Why aren't Comp Consultants, Recruiters etc. COmpensated with Performance-based pay (by the issuing company) - 7 March 2010

Executive
compensation has been in the spotlight for many years. Structuring the
compensation package for senior management of public companies, where
there is separation between ownership and control, is an example of the
agency problem. Senior management, the agents, have to be offered the
right set of incentives to align their interests with those of the
shareholders, the principals, or so the theory goes. Left to
compensation consultants, the solution to this agency problem has lead
to profit-related bonuses and so-called, long-term incentives in the
form of stock options and share grants.

But the agency problem is quite pervasive, and it is interesting to
examine some other examples in order to compare their compensation
structures with those employed by compensation consultants for senior
management.

Compensation consultants are another example of agency - they are
the agents of companies (boards of directors) who retain them. How are
they paid? Generally they are paid a fee for service, where somehow the
fee tends to be positively correlated to the aggregate value of the
compensation package for the CEO and one or two other key members of
senior management. The fees are not contingent on how effective the
proposed compensation package is in motivating senior management,
and/or in producing superior results for the shareholders (whom boards
of directors represent).

Executive search firms provide a further example of agency. They are
hired to find the “right” people to fill senior management vacancies.
They too are paid a fee for service, with the fee correlated to the
aggregate value of the compensation packages of the executives they
recruit. The fees are not contingent on the performance/success of the
people whom they recruit.

These two examples raise the following questions. If these agents
receive no performance-based compensation, why should CEOs and other
members of the senior management team receive any such compensation? On
the other hand, if performance-based compensation is necessary to align
the interests of agents and principals, why don’t these agents receive
most of their fees contingent on the success of the advice they offer?

Management consultants are another example. Most often they receive
a flat fee regardless of whether their advice is used, or if used,
regardless of whether it creates any value. There have been some cases
where part of the fees paid to management consultants have been
contingent on the value of their advice.

Investment advisors, generally investment bankers, are yet another
example. They are usually paid a monthly work fee, independent of
outcomes, and a “success”-based fee. However, the success-based fee
rarely has anything to do with whether their advice enhances the values
of the clients’ companies over time. Rather, the fee is tied to doing a
deal, regardless of its longer-term merits.

One might believe that reputation would compel investment bankers to
strive to provide advice which truly is in the long-term interests of
their clients and shareholders. (One might similarly believe that
reputation might be sufficient to motivate CEOs to create value for
their shareholders.) But what matters more for their reputation are the
annual rankings in the number of deals, the total value of the deals
and the total fees generated. The long-term value/success is largely
irrelevant because senior management always can be blamed, as with
management consultants as well, for poor execution.

In most cases of agency (lawyers, advertising agencies, public
relations consultants, auditors, credit rating agencies), compensation
is rarely linked to performance. So why should CEOs’ compensation be
linked to performance? Why not just pay them a fixed annual amount, and
let shareholders decide whether their contracts should be renewed? The
real super-stars, and there are very few, will be richly rewarded when
they test the free agency market for their services. The mediocre will
not be overpaid and will join the unemployment lines much more
frequently than they do at this time.

Or, if performance-based compensation is critical for solving the
agency problem, then why are not all agents paid most of their fees
contingent on the longer-term value of their advice? Would Goldman
Sachs have given Greece different advice if their compensation were
linked to the long-term financial stability of the Greece?

The opinions expressed in this blog are personal and do not
reflect the views of either Global Brief or the Glendon School of
Public and International Affairs.