In an era of unprecedented concern about executive pay, consulting firms and their clients are wondering about the question "Can a consulting firm provide advice on executive pay in addition to other services?" The potential conflict is that if a consulting firm recommended a low pay package for an executive, might he be tempted to find another consulting firm for the other work as well. Could an executive use the prospect of consulting work as a way to bribe a firm into giving him a larger pay package?

Of course, many people in the industry will tell us there is nothing to worry about. Pay consultants are part of a different group at the firm and so there's no conflict, only a PCOI (Perceived Conflict of Interest). Doesn't this sound a little bit like the "Chinese Wall" between the investing banking wings of firms and their analysts? Of course, we need only read a little bit about Henry Blodget to see how well that worked out.

Granted, most people will operate with integrity and, in most cases, it is only a PCOI (I love that acronym). But the issue is that potential conflicts of interests create the potential for unscrupulous conduct. Criminologists study fraud and white collar crime in terms of the fraud diamond (PDF-May take a minute to load). Fraud requires incentive, opportunity, rationalization, and capability. Strong corporate governance and internal controls focus on eliminating the opportunity. Only be eliminating conflicts of interest involving consultants and the companies they work for can we eliminate the potential for poor conduct. PCOI's can create the critical opportunity for an unsavory individual to engage in misconduct.

Remember Arthur Andersen? The company was engaged in auditing work and consulting work for Enron, but the consulting work was by far more profitable. To ensure that they didn't lose their consulting contracts, the company looked the other way, and in some cases actively assisted, in Enron's accounting fraud. We all know how that worked out and similar problems (albeit on a much smaller scale) can occur when consulting firms are presented with conflicts of interest.