I know complaining about executive compensation is a popular topic of discussion on this board, but I have not seen a discussion of viable strategies to actually reform pay practices. Without going into too much technical detail, I would like to lay out what I see as realistic changes in the law that could actually have a major impact.
1. Impose a hard $500,000 cap on annual cash compensation for executives at public companies. Under the current section 162(m) of the code, companies are not allowed to deduct compensation in excess of $1MM unless the additional compensation is "performance based." The performance based exception became the exception that swallowed the rule, making 162(m) largely inconsequentional. In recent years, 162(m) has been expanded to include a hard $500,000 cap on compensation for certain employees (executives at companies that received and did not repay TARP money, and certain health insurers) with no performance based exception, and I think this could easily apply to all public companies. To prevent companies from just taking the tax hit (the penality for violating 162(m) is just that the employer does not get to take a tax deduction for the amount in excess of the cap) the Nasdaq and NYSE listing criteria should be amended to require companies to solicit shareholder approval of any payment of compensation which would not be deductible, and to delist any company who makes a nondeductible payment without obtaining shareholder approval.
2. Tax options, restricted stock awards and other forms of restricted equity on grant, and again at sale. Under the current system (largely governed by section 83 of the tax code), you are not taxed on the grant of options, even though they are securities with a value that can be determined (normally, we use the black-scholes value). When you exercise those options, you are taxed on the value of the options (less the exercise price you pay) and then you are taxed again when you sell them. Restricted stock and other forms of restricted equity are normally taxed once the restrictions lapse, and then again when you sell them, although we allow people to elect to be taxed on the value at grant (usually at or close to zero) to avoid paying tax on vesting. If we required taxation at the time of grant, vesting and exercise for all equity awards (and allowed deductions if you forfeited your award) and prohibited the current practice of allowing "cashless exercises" by effectively selling some shares back to the company in exchange for having the company pay the exercise price of the remaining options, then we would make it much harder for people to accept huge equity awards (these equity awards account for much of increased executive pay).
3. Apply eligiblity nondiscrimination rules similiar to the rules that apply to pension and 401(k) plans to nonqualified deferred compensation plans and equity plans. This would mean that if a company wants to allow executives to defer their income or wants to grant equity awards, it would also have to extend those opportunities to the majority of employees. I don't think that we would want to apply benefit nondiscrimination rules to these plans (since these plans are not conferring the sort of profound and very expensive (to the government) tax benefits that pension and 401(k) plans do) but requiring everyone to have access to the plans would really help bring ordinary employee compensation more in line with executive compensation from a structural perspectve.
4. Revise the golden parachute rules to require that all recipients of golden parachutes waive the right to receive amounts in excess of the statutory limit if not approved by shareholders. This is already how golden parachutes work in practice at private companies (executives are asked to waive their rights, pending shareholder approval), but not at public companies (which just take the tax hit, and even pay the executives extra money to pay the excise taxes). The golden parachute rules should also apply to all severance payments, not only severance payments made in connection with a sale or other change in control of the company. Like 1, above, the Nasdaq and NYSE listing criteria should be amended to delist any company who makes a nondeductible payment without obtaining shareholder approval.
These are not the only possible changes, but, with the exception of (2), they are all just applications of existing rules to broader classes of executives, and each of them would be pretty difficult to structure around, since even if companies wanted to gross up their employees so that the executives don't feel excise taxes, they would have to count that amount towards the $500,000 cap from (1). I have not included as many reforms for private company executive compensation, which is both a more difficult issue to deal with (private companies are subject to less regulation and oversight than public companies) and in a sense, less pressing (since executive compensation decisions at private companies tend to be made in close consultation with the owners). I am happy to go into more detail on any of the above, or to explain why other solutions may or may not work.
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My knowledge of accounting rules is limited, but I agree that as a general matter, tying tax values and book values together more closely for compensation expenses could have a big impact on both the form and amount of compensation paid to executives. In a way, this would be the inverse of how changes to accounting rules which require more disclosure of pension plan funding are helping to drive companies away from affiliating themselves with companies that maintain these plans (the effect will be felt even more strongly once these rules start applying to union pension plans).
On the other hand, I already can see how it'll work out...companies will just outsource everything below manager level to temp companies or contractors so that the poorest employee is still making $100k a year.
There are a number of problems with an idea like this. As you pointed out, a system like this would encourage companies to hire fewer low wage employees. It may also push companies to use more part time, temporary or seasonal workers, since these would presumably be excluded. Focusing on pure dollar values is also not ideal, because companies will just respond by giving executives more valuable compensation, like stock.
I really think that the best approach is incremental but profound changes, instead of trying to completely replace out current system. changes like those I outlined above would make for more organic changes in executive compensation practices, lowering transition costs and lessening the risk that major new loopholes will be discovered.
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That only makes it slightly better temporarily, not a permanent solution. There will always be greedy execs manipulating the system for their own gain.
What's needed is a total overhaul with compensation that has effective enforcement by the government to neutralize them whenever they exploit loopholes. Perhaps banning them from said industries whenever they're caught gaming the system. Making it a fraudulent offense that has severe punishments by the law would help, as well.
edit: Salary caps are needed. As well as getting only a single bonus a year, within limits (they'd have to capped at reasonable rates).
The sugestions I laid out above are all concrete changes based on expanding the most effective curbs on excessive executive compensation we have in America now. There are honestly too many companies and executives out there for the government to effectively police the situation. This is why I think an increased focus on shareholder voting, enforcement of these votes by the listing bodies for the major stock exchanges, and rules ensuring that companies don't just pay excise taxes due from the executives is the way to go. These types of changes have low transition costs, good integration into the existing system (meaning fewer loopholes), low enforcement costs, and provide for more direct shareholder control.
Agreed. That said, all contracts like that should be binding. Shareholders should have the ultimate say in those contracts. The board of directors shouldn't be able to have members that have conflicts of interest with the company or anyone in its highest positions, like the CEO, president etc. Anyone breaking that should be penalized harshly with fines and banning.
Why? Execs shouldn't be able to have unlimited wealth. Unless they do most of the work for the company. It will stop encouraging greedy execs into positions of power.
In those situations the company should be throughly audited by the IRS to make sure everything they say is trustworthy. That said, I like those penalties for an exec who failed their company. Their golden parachute should be nullified, too.
That being said I approve of shareholder approval of executive pay packages over a certain amount instead of a hard cap.
Which are still too minimal IMO.
Then the government needs to figure out a way to expand their resources. Like every company with x profits is forced to donate an amount to the IRS each year, the larger the company the larger the proportion.
I agree that the items you're suggesting need to be addressed.
Make stock options and such income.
Tada. You no longer have to worry about controlling the behavior of companies, you just fix the externalities of that behavior.
Please, execs are replaceable. There will always be someone filling the vacuum once they leave. It will take a while to get everything up to snuff but with less greedy assholes around the boardrooms, management or exec positions the American corporate world may not be the cesspit it is today, especially in the banking & realty industries.
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I seriously doubt they're all going to give up status and living conditions just because their tax rate went up a bit. It's about as likely as going galt on a mass scale. I will agree that letting people learn here and then promptly kicking them out instead of keeping them is a bad thing though.
Altering how compensation is taxed and put on the books would help a lot. I'd love some form of rules on board memberships as well, but I doubt they'd happen. Every public company I've worked for recently has had some stupid circle of board members who were all members of each other's boards/CEOs in the mix. So it was basically a giant circlejerk to give each other favors, including determining compensation.
The OP's suggestions seem fine, part of the reason people are upset is that it's.. depressing to see your executives all get pay raises/massive bonuses in an okay year, while everyone else is told there's no money for bonuses this year. It gives the distinct impression that the business feels it could run everything just fine without any of the employees.
I really doubt that this would do anything at all, really. Most business schools have corporate governance and ethics classes anyway. And it's not like someone goes right from an MBA to being a CEO.
Agreed.
It's clearly not enough, so changing is it a necessary tool in altering corporate attitudes before they start screwing with actual corporations with many employees jobs on the line. IIRC many classes have their students reading Ayn Rand, which should not be allowed.
This kinda shit needs to stop, as well.
http://bloomberg.com/news/2011-05-05/schools-find-ayn-rand-can-t-be-shrugged-as-donors-build-courses.html
It's really fucking shitty, ayn rand's ideas have no business being in a classroom that dresses itself up as being about economics
Because in Amurrca, Unions are a bad thing as it is apparently.
Legislating a cap on executive pay is already dangerous territory to tread in. But the idea that it cannot be a certain multiplier more than the lowest earner's pay is a start for making it fair.
That may be a bit much though, fun to think about.
Making companies responsible for the decisions they make in their supply chain is an important part of reigning in their amoral behavior. It is not just with wages but human rights, environmental damage, corruption. Finding a way to actually make it stick would be tricky but it would be a good idea to start this kind of forcing responsibility with wages.
The temporary and part time workers for a multiplier system could have their hourly wage multiplied by a full time work scheduled to set their :"actual" wage to prevent this kind of manipulation. So (Hourly wage x 2000 = yearly wage) or something like that. They don't need to be exempt for this to work.
The main problem I have with the OP proposals for altering behavior thorough tax policy is that even if it is not advantageous to the company to pay $Texas to their executives it is still likely they would do the same thing, because that is the standard culture and operations. If you do not combine tax reforms with governance changes for public corporations then the same system will just be operating on slightly different rules. They will still find a way to keep funneling money into a very small number of hands in the company.
I'm much more concerned with simply taxing the highest percentiles of income earners in a way that makes sense.
Pluto was a planet and I'll never forget
In particular the difficulties of taxing income "fairly" as identified by spacekungfuman (which generate the problems #2, #3, and #4, IMO) spring from the large variety of possible ways in which compensation can be instrumented.
From my armchair it seems that the obvious (and relatively minimally intrusive) answer would be to restrict possible compensation to cash when independently-verifiable conditions X are met. No complication regarding business ownership, evaluating in-kind compensation, etc. On the corporate balance sheet it looks purely like a wholly unsecured bond, which is de facto what rank-and-file workers have anyway when they work for a check at the end of the month.
Incase the effect of my proposal wasn't clear, here is what would most likely happen if all of my proposed reforms were enacted:
1. Executives at public companies would be limited to $500k per year in aggregate compensation, including cash and equity, unless shareholders approved greater payments.
2. Executives would be taxed on the value of equity when they receive it, and again on sale.
3. Ordinary employees would be given a mix of cash and equity (like executives), and would be given more control over the timing of income recognition.
4. Golden parachutes would not be payable without shareholder approval.
These are pretty signifigant changes in the way that compensation works in America, and they would all be really hard to get around (much harder than carried interest reform, for example).
I think this helps to show that if you leverage existing institutions (like large investors through ISS or the stock exchange listing authorities) and encouraging shareholder involvement and activism, you can achieve meaningful reform (or at least limit increases in comp) without creating an expensive and administratively challenging administrative scheme. Keep in mind, this is a VERY profitable company, but a shareholder with an interest in maximizing its returns cared enough about compensation to actually get it reduced.
I suppose so, but the current environment really, really doesn't make 'shareholder activism' all that feasible so this type of story is doomed to be pretty rare. It is very hard to pass shareholder resolutions in the US and corporate boards frequently abuse so called 'shareholder rights plans' to make removing themselves almost impossible. Which is one reason why I'd like to see 'poison pills' et al made illegal. I don't think it would be too politically contentious in the current climate as we are far removed from the Barbarians at the Gate type scenario that propelled these to the forefront. And it might help a little at the margins.
Creating a disincentive for the executive to get paid more doesn't really do anything from the company's perspective; you should create a disincentive for the company to pay more, too.
While that is true with respect to who bears a legal obligation to pay, in practice companies often gross up executives who are hit with excise taxes, so the impact on the bottom line is the same. That's why in the OP I proposed delisting companies who pay excise taxes on behalf of employees. For those who didn't see it, here are my suggestions:
1. Impose a hard $500,000 cap on annual cash compensation for executives at public companies. Under the current section 162(m) of the code, companies are not allowed to deduct compensation in excess of $1MM unless the additional compensation is "performance based." The performance based exception became the exception that swallowed the rule, making 162(m) largely inconsequentional. In recent years, 162(m) has been expanded to include a hard $500,000 cap on compensation for certain employees (executives at companies that received and did not repay TARP money, and certain health insurers) with no performance based exception, and I think this could easily apply to all public companies. To prevent companies from just taking the tax hit (the penality for violating 162(m) is just that the employer does not get to take a tax deduction for the amount in excess of the cap) the Nasdaq and NYSE listing criteria should be amended to require companies to solicit shareholder approval of any payment of compensation which would not be deductible, and to delist any company who makes a nondeductible payment without obtaining shareholder approval.
2. Tax options, restricted stock awards and other forms of restricted equity on grant, and again at sale. Under the current system (largely governed by section 83 of the tax code), you are not taxed on the grant of options, even though they are securities with a value that can be determined (normally, we use the black-scholes value). When you exercise those options, you are taxed on the value of the options (less the exercise price you pay) and then you are taxed again when you sell them. Restricted stock and other forms of restricted equity are normally taxed once the restrictions lapse, and then again when you sell them, although we allow people to elect to be taxed on the value at grant (usually at or close to zero) to avoid paying tax on vesting. If we required taxation at the time of grant, vesting and exercise for all equity awards (and allowed deductions if you forfeited your award) and prohibited the current practice of allowing "cashless exercises" by effectively selling some shares back to the company in exchange for having the company pay the exercise price of the remaining options, then we would make it much harder for people to accept huge equity awards (these equity awards account for much of increased executive pay).
3. Apply eligiblity nondiscrimination rules similiar to the rules that apply to pension and 401(k) plans to nonqualified deferred compensation plans and equity plans. This would mean that if a company wants to allow executives to defer their income or wants to grant equity awards, it would also have to extend those opportunities to the majority of employees. I don't think that we would want to apply benefit nondiscrimination rules to these plans (since these plans are not conferring the sort of profound and very expensive (to the government) tax benefits that pension and 401(k) plans do) but requiring everyone to have access to the plans would really help bring ordinary employee compensation more in line with executive compensation from a structural perspectve.
4. Revise the golden parachute rules to require that all recipients of golden parachutes waive the right to receive amounts in excess of the statutory limit if not approved by shareholders. This is already how golden parachutes work in practice at private companies (executives are asked to waive their rights, pending shareholder approval), but not at public companies (which just take the tax hit, and even pay the executives extra money to pay the excise taxes). The golden parachute rules should also apply to all severance payments, not only severance payments made in connection with a sale or other change in control of the company. Like 1, above, the Nasdaq and NYSE listing criteria should be amended to delist any company who makes a nondeductible payment without obtaining shareholder approval.