Most folks seem to agree that executive compensation – especially CEO’s pay – is wildly excessive.
How did it get that way?
As partial explanation, I think that two well-intended legislative actions started the ball rolling with unintended consequences.
The first is Item 402 of SEC Regulation S-K:
Item 402 – Executive Compensation. The SEC regulations governing disclosure of information about executive compensation are contained in Item 402 of Regulation S-K. Pursuant to Item 402, a public company must disclose to its shareholders information concerning compensation paid to its CEO and its four most highly-compensated executive officers (its “named executive officers”) during the last fiscal year, as well as its directors, in certain registration statements, its annual proxy statement, and certain other filings under the Securities Exchange Act of 1934, as amended (“Exchange Act”).
The motivation for the regulation is clear: provide shareholders with transparency into the way that top execs were being paid.
Sounds like a right thing to do, right?
The unintended consequence: For the first time, top execs had factual benchmarks re: how they racked up relative to their peers.
Underpaid execs used the data to get pay boosts; highly paid execs used the data to maintain their spreads against their less deserving peers.
For many (most?) execs, compensation became a manhood issue … and of course, bigger is always better.
Executive comp wars broke out and escalated.
A second legislated driver was Section 162(m) of the Internal Revenue Code:
Section 162(m) of the Internal Revenue Code generally limits the corporate tax deduction for annual compensation paid to executive officers named in the Summary Compensation Table to $1,000,000, unless the compensation satisfies the requirements for performance-based compensation. Stock options, performance shares, and cash-equivalent performance shares granted under the Company’s stock incentive plans have generally been entitled to the full tax deductions available because the compensation has been considered performance-based and not applied against the $1,000,000 limit.
Again, well intended.
Why should taxpayers subsidize over-sized exec comp? If companies want to pay execs more than $1 million, they can … they just can’t take a tax deduction for the amount over $1 million.
So, what’s the problem?
We,, it’s the qualifier: “unless the compensation satisfies the requirements for performance-based compensation”
To circumvent the rules, companies shifted to performance-based compensation tools … think bonuses and stock options.
So, bonuses became a larger part of comp packages and stock options became the major mechanism for “rewarding” execs.
In 1970, stock based compensation was less than 1 percent of compensation.
By 2000, it was around half of compensation.
Source
The heavy emphasis on stock options certainly provided some motivation to execs to boost share prices (that’s good), sometimes by focusing too aggressively on short-term results (that’s bad).
More to come …
>> Latest Posts
