Closing Tax Loophole May Not Move the Needle on CEO Pay

Closing Tax Loophole May Not Move the Needle on CEO Pay

In the 1993 federal budget, the administration of then-US President Bill Clinton created a rule that capped the tax deductibility of top executives’ compensation at $1 million, unless that compensation was “performance-based.” While Clinton had campaigned on the cap as a means of reducing the growth of CEO pay packages, the policy backfired and caused them to grow as companies shifted executive compensation into stock options and performance bonuses, taking advantage of the loophole.

The question of how to measure CEO performance for the purposes of calculating their paycheck (or whether to do so at all) has become a matter of significant debate, driven by the realization that it has not moderated the growth of pay among CEOs and other top-dollar members of the C-suite. The tax reform bills Republicans are currently trying to push through Congress propose to eliminate this loophole, which would raise $9.3 billion in tax revenue over a decade, but the Washington Post’s Jena McGregor points out that closing the loophole may not rein in the growth of executive pay packages just because creating it helped them grow:

Executive pay experts and activists said in interviews that companies are unlikely to severely limit the size of their CEOs’ compensation just because a big portion of it — the vast majority of those multimillion-dollar packages are paid in incentive-based pay — is no longer deductible. …

That’s for several reasons. For one, particularly relative to the big tax cuts companies stand to receive in the GOP tax bills, the hit they’ll face from closing the loophole won’t mean much for many companies. … Companies also already regularly forfeit the deductions when they pay salaries above $1 million, for instance, or when they give out restricted stock grants that are not tied to performance, a common practice.

Furthermore, the tax treatment of executive compensation isn’t the only of many factors driving how organizations set these salaries: Other potential factors, such as talent market trends, the growing public role of major-company executives, or the common ownership of competing companies by large asset management firms, will still come to bear on how chief executive, financial, and operating officers are paid. Potentially more impactful than tax policy are the increasing level of transparency in compensation today, a growing demand for “say on pay” among shareholders, and the brand and public relations risks of having your CEO’s “excessive” salary held up as an example of income inequality.

Public policy is moving other levers as well, however: The Securities and Exchange Commission is moving ahead with enacting a rule written in 2015 that will require public companies to disclose the ratio between the compensation of the CEO and the median annual compensation of every other employee in their proxy statements, starting with this fiscal year, and the impending requirement has many companies concerned about how they will frame those disclosures for their employees. The city council in Portland, Oregon voted last year to impose a tax on companies licensed to do business in the city whose chief executives earn more than 100 times their median employee.

Other governments have been looking at ways to leverage shareholder power and give investors greater influence over how their companies reward their executives. The UK, as part of a suite of corporate governance reforms, has floated the idea of a public register showing all companies whose executive pay plans were opposed by at least 20 percent of shareholders. In Australia, a policy that has shown promise is the “two strikes” law passed in 2001, which stipulates that if at least 25 percent of a company’s investors vote against approving its remuneration report at two consecutive annual shareholder meetings, that automatically triggers a vote on whether to force the entire board, except the managing director, to stand for re-election within 90 days.