Comp Rx: Kill Employment Contracts?

Amid the tussle over what to do about executive compensation, a radical solution is floated.

Employment contracts for CEOs and other senior executives were not very common until about 20 years ago. And according to a noted compensation expert, investors’ interests would be served well by a return to the old way.

Excessive executive pay could be limited by a simple but radical change: the elimination of employment contracts, according to Bruce Ellig, a noted author, speaker, and advisor to corporate boards on compensation and human resources issues. To effectively accomplish that, he suggests, Congress could entirely disallow tax deductions for compensation made under a contract — for all companies, not just financial services firms that participate in a federal bailout program.

Companies that then signed executives to lucrative employment contracts anyway would expose themselves to possible shareholder lawsuits for misusing company assets, according to Ellig, a former longtime head of human resources at Pfizer Inc. He further suggests that Congress could impose an excise tax on contract recipients for income received under contracts.

Without employment contracts, companies would be able to compensate departing executives reasonably, rather than being tied to exorbitant payments contractually agreed to years earlier, Ellig tells CFO.com. “I talk to people on boards all the time who say, ‘Oh, our hands are tied, the CEO has an employment contract.’ Well, you shouldn’t have given him a contract. You wouldn’t have the problem, would you? Why don’t you go talk to him and see if he’ll agree to tear it up?”

Taking a stance against employment contracts is both the right thing and the fair thing to do, according to Ellig. “If you’ve got shareholders losing value and employees losing jobs and the company teetering on the brink of bankruptcy, why should an individual who was a main source of the problem be protected?” he says. “If the employment-at-will principle is fair game for everybody else in the organization, it should be fair game for executives as well.”

Significantly diluting the CEO’s risk of poor performance may be ill-advised, as he surely will take comfort that he’ll be protected in case the company fails or he is terminated. “That’s not a positive motivation,” says Ellig, who has written seven books, including “The Complete Guide to Executive Compensation” and “The Evolution of Employee Pay and Benefits in the United States.”

Certainly, the reason companies give employment contracts is to secure and retain top executive talent. But Ellig says executives will have enough incentive if a new employer agrees to pay for the value of anything the executive is leaving behind at his old job to take the new one, and awards stock that will vest over a period of years. Then, if the executive left within a specified time period, he would have to pay back the cash and wouldn’t get the stock.

All of that can be agreed upon in the typical type of offer letter that many employees, both executives and non-executives, receive. It could even be agreed upon orally.

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