Wednesday, July 7, 2004
Interesting piece in today’s Wall Street Journal (at C1) concluding, as critics of Section 280G have long contended, that the golden parachute rules do not effectively limit executive compensation: As CEOs Miss Bonus Goals, Goalposts Move; Companies Adjust Target Levels, Keeping Their Executives Happy; IRS Pay-Curb Ignored:
If at first you don’t succeed, then change the rules for measuring success.
That’s the mantra of many corporate-compensation committees these days. Despite Internal Revenue Service rules aimed at reining in excessive executive pay, many companies are still paying executives hefty bonuses — even when they miss the performance goals that are supposed to trigger the payouts.
Companies typically do this by changing plans midyear, as it becomes clear that they won’t hit the original targets, sometimes opting to pay more taxes at the expense of profits and shareholders. Critics say this shows that the IRS rules are ineffective and should be scrapped….
Tying executive compensation to corporate performance has its roots in congressional legislation of a decade ago, when investors were alarmed over ballooning pay amid weak corporate results. As a result of the legislation, the IRS restricted publicly traded companies to deductions of $1 million apiece in compensation for the chief executive and four other top executives — unless the compensation was related to “performance.” Then, the deductible income is theoretically unlimited.
As a result of the IRS rules, many companies now have complex performance measurements for determining executive bonuses. So what happens when a company moves the goalposts as AT&T Wireless did in 2002 and Cigna in 2003? The IRS rules allow publicly traded companies to go ahead and deduct the performance-related compensation in excess of $1 million if the changes are made 90 days or less into the fiscal year in question. But after that, any pay in excess of $1 million can’t be deducted.
As it turns out, when faced with the choice between sticking with the original plan and stiffing their executives on bonuses, or altering the plan, paying fat bonuses and forgoing the extra tax deduction, many companies opt for the latter.
For the past year, the IRS has conducted extra audits into the way companies conform to laws permitting such tax deductions. Meanwhile, some question the effectiveness of using tax incentives to rein in executive pay.
As part of its investigation into collapsed Enron Corp. last year, the U.S. Senate Committee on Finance looked into the energy company’s adherence to the IRS rule and concluded that it had “little, if any, effect on the overall level of compensation paid to Enron executives or the structure of compensation.” In a lengthy report, the committee concluded that the IRS rule should be repealed: “It is often difficult for tax laws to have the desired effect on corporate behavior. Taxpayers may simply choose to incur the adverse tax consequences rather than change their behavior.”
“If you want to limit executive pay, you’d say, ‘Nobody should get paid more than $1 million,’ ” says Robert McIntyre, director of Citizens for Tax Justice, a tax-policy research group.
