An interesting debate has emerged on the letters pages of the Financial Review between recruitment consultant Chris Thomas (a partner of recruitment firm Egon Zehnder) and Dean Paatsch, head of proxy adviser, RiskMetrics in Australia. Thomas appeared somewhat aggrieved at the so-called power of proxy firms, which provide advice on corporate governance issues to institutional shareholders.

The rapid rise of proxy advisers, especially that of RiskMetrics (and the lower-profile Corporate Governance International) has had a profound effect on how companies treat shareholders. RiskMetrics was the key driver behind publication of the appalling and secretive management agreements entered into by the likes of Babcock & Brown and Macquarie Bank and their satellite funds (such as Babcock & Brown Infrastructure and Macquarie Airports). Well before any broker or analyst twigged to the fact that companies such as Allco Finance Group, MFS and Babcock were a debt-riddled house of cards, RiskMetrics had long advised clients as to their inherent risks and unsustainable business models.

RiskMetrics is, however, better known for its pioneering work in curbing runaway executive remuneration. It is in this area that appeared to enrage Thomas. The only problem is, before writing to the Financial Review, Thomas neglected to investigate exact how proxy firms operate. In fact, his knowledge of their procedures appears to have been gleaned solely from a couple of his disgruntled clients (Thomas conceded he didn’t bother to read any of proxy advice nor contact any institutional investors who utilise that advice), instead, claiming that:

It customary that when more an annual report — and therefore a remuneration report — is released, that one or other spokesmen for a proxy advisory firm issues an almost immediate to criticism related to the structure which the remuneration based. Because for most people the remuneration of CEOs will always be seen as excessive, the moral high ground is apparently immediately grabbed.

However, in reality that is not how proxy firms operate. Specifically, proxy firms spend a substantial amount of time (sometimes weeks) analysing individual remuneration reports and company structures (especially for higher profile companies). The proxy adviser will prepare a detailed report (often upwards of 25 pages), which is sent to clients. While a recommendation in relation of each resolution being proposed is usually given, clients are certainly free (and often will) choose not to follow the views of their adviser. (In the same sense that a client will often ignore the findings of a a research report provided by their broker).

Further, in RiskMetrics case, in the event of almost every adverse recommendation it makes, will contact the company involved before publication and seek their views. For example, if a company has provided insufficient disclosure regarding remuneration policies, RiskMetrics will attempt to glean further information. If further details are provided, the information is duly onto clients and the recommendation may change to support the company’s resolution. This provides a “win-win” for shareholders (who are given a better understanding of remuneration policies) and for the executives and directors who avoid the embarrassment of an adverse shareholder vote. (If the company’s view fails to convince the proxy adviser, they will still provide both sides of the argument to clients to allow them to make a fully informed decision).

Admittedly, this doesn’t appear a concern to Thomas, who most likely earns millions of dollars per year from companies who themselves pay even more millions of dollars per year for CEOs that Thomas recommends.

Thomas then noted:

Boards of directors, like any shareholders, have no incentive to overpay executives. Rather, with the assistance of their independent remuneration advisers, and hopefully, some discussion with key shareholders, they seek to come up with a formula that will attract, motivate and retain outstanding executives.

The notion that boards have no incentive to overpay executives or that remuneration consultants are “independent” makes Alice in Wonderland look like a piece of non-fiction. But in that regard, we defer to the views of Warren Buffett, who told shareholders in 2005 that:

Too often, executive compensation in the US is ridiculously out of line with performance. That won’t change, moreover, because the deck is stacked against investors when it comes to the CEO’s pay. The upshot is that a mediocre-or-worse CEO — aided by his hand-picked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo — all too often receives gobs of money from an ill-designed compensation arrangement.

Ironically, a fairer criticism of proxy advisers is that they too often err on the side of management — for example, proxy advisers recommended shareholders vote in favour of Mark Rowsthorn’s remuneration package at Asciano in 2009, despite Rowsthorn being awarded a substantial bonus while the company lost $244 million and was forced into a massively diluted capital raising. Or that proxy advisers recommended in favour of Geoff Dixon’s lavish remuneration packages (making him the highest paid airline executive in cash terms globally) at Qantas until 2007.

As for Thomas, aside from getting his criticism completely wrong, he perhaps should be tending to issues a little closer to home. Thomas’ firm, Egon Zehnder (he has worked there since 1979), was responsible for the appointment of former Telstra CEO Sol Trujillo.

Trujillo was at the helm while Telstra’s share price fell by 40%, courtesy of his foolishly adopted hostile stance with regulators and hundreds of millions spent on consultants. The money that Telstra shareholders paid Thomas’ firm for finding Trujillo was possibly not well earned — a quick Google check would have revealed that Trujillo’s previous employer, US West, was once dubbed “US Worst” for its horrendous customer service (Telstra customer service worsened under Trujillo), another former employer, Graviton, went bankrupt shortly after Trujillo’s tenure as CEO, while Sol lasted barely 13 months at yet another employer, Orange, but still managed to cause the loss of $US550 million through a mistimed Thai venture.

Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed, featuring a chapter on Telstra and Sol Trujillo (available from Booktopia). Schwab consulted briefly to RiskMetrics in 2008.