Comp Rx: Kill Employment Contracts?

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

In both of those cases, the agreements may constitute legally binding contracts. But to support Ellig’s view of disallowing the tax deductibility of payments made under contracts, Congress and the IRS could stipulate that an “employment contract” is one that, for example, is prepared by outside counsel, agreed to and signed by the board, and lays out all terms and conditions of employment in detail including length of employment and amounts to be paid upon severance.

Ellig acknowledges that he hasn’t heard anyone else making such a suggestion, adding that “I’ve always been a maverick.”

Indeed, some other observers view it as an extreme approach. “To disallow all deductions for executive compensation would go far beyond what is necessary,” says Mark Poerio, an employment practice partner at Paul, Hastings, Janofsky & Walker. Beside, he notes, it wouldn’t solve the problem of excessive compensation anyway; companies would still pay significant incentives in order to be competitive in the marketplace. “I don’t see why the fact of whether it’s stated in an employment agreement should make the difference in whether it’s deductible,” Poerio says.

Furthermore, in the past, limiting deductibility has not deflated executive pay, notes Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. In fact, it has had the opposite effect. In 1993, the IRS decreed that cash compensation over $1 million per executive annually would no longer be deductible, triggering the rise of stock options as the leading compensation tool.

A reduction in deductibility for compensation expense to $500,000 per executive was part of the financial services bailout bill that the House of Representatives voted down on Monday. “That was problematic,” Elson says.

Elson adds that he thinks concerns over executive compensation should be handled separately from the bailout legislation, because it’s making legislators take their eyes off the ball as to what’s really important.

Poerio too is frustrated at the bright spotlight on executive compensation as part of the bailout discussion. “It is very disproportionate — we’re talking about $700 billion, and what’s at stake with regard to compensation is a drop in the bucket,” he says. “It resonates with Main Street America, and executives are overpaid and we should cut them back. But if that ever becomes part of how somebody makes a decision on this, that is skewed and wrong.”

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