The bill to allow the federal government to bail out financial institutions laden with toxic debt included a compensation rule that would have elevated finance chiefs to the same “covered executive” status as CEOs, disallowing tax deductions on portions of their pay.
The bill was voted down by the House of Representatives today, but more efforts are certain, and executive compensation is equally certain to be part of the discussion.
The defeated legislation would have limited the tax deductibility for compensation expenses to $500,000 per executive annually at financial firms that sell troubled assets to the government via an auction for more than $300 million. That is half the amount that all other public companies currently can deduct under IRS Section 162(m).
That provision would apply to the firm’s CEO, CFO, and anyone else who is among its top three highest-paid executives.
“Historically, only CEOs were explicitly named in Section 162(m),” says New York-based corporate tax expert Robert Willens. “Now both CEOs and CFOs are singled out for special treatment.”
At present a $1 million cap is required for CEOs and the next four highest-paid executives, but does not apply to performance-based pay and commissions. According to the Institute for Policy Studies, most companies cap executives’ base salaries to $1 million and then add other types of compensation that are deductible. Under the proposed bill, those performance-based compensation and commissions would not not have been deductible.
However, many observers did not think the bill’s executive-compensation provisions were nearly sufficient. In addition to the tax-deductibility clauses, it included “limits” on financial incentives for executives “to take unneccessary and excessive risks that threaten the value of the financial institution”; a clawback provision applicable to bonus or incentive compensation based on “statements of earnings, gains, or other criteria” later proven to be materially inaccurate; and a prohibition on golden parachute payments.
“What I find disappointing is that they didn’t put a clear limit on what executives can make,” says Sarah Anderson, director of the global economy project at the Institute for Policy Studies.
The pressure of the current financial crisis might have been an opportunity to make more sweeping changes to executive pay policies, says Paul Hodgson, a senior researcher at The Corporate Library, but changes to the tax deductibility cap are easily reversible. Moreover, once a company repays the government for assets that were purchased, the new curbs would disappear.
“Companies can just say that they’re going to pay the tax, and shareholders will end up footing the bill,” says Hodgson. “If you’re going to put a limit on pay, put a limit on it. Don’t just eliminate the tax deduction.”
For his part, Willens suggests that the plan is more symbolic than substantive and would have more teeth if it was extended beyond just CEOs, CFOs, and a few other top earners. Still, it could move shareholders to be more vocal about limits on executive compensation.
“Shareholders will be highly indignant if the corporation loses a tax deduction even for a limited amount of executive pay,” says Willens. “They will demand that the compensation paid to these individuals be reduced so that the after-tax cost to the company is the same as it would be if the entire amount was deductible.”