Early in his Administration, President Clinton announced with great fanfare his plan for curbing excessive executive pay.
He told the American public that the government would no longer subsidize pay packages above $1 million a year and that if a company persisted in paying above that level, it would lose its corporate tax deduction on the excess. Boards of directors were to be given two harsh choices: Cut the pay of senior executives to $1 million or less each--or help reduce the government's budget deficit by anteing up more in corporate taxes.
So how has Clinton's plan fared in its first full year of operation?
Well, the President has always had as one of his key goals the creation of more jobs for Americans, and high-paying jobs at that. From that perspective, his $1-million pay cap is a huge success, because there are more jobs than ever--for securities attorneys, accountants and executive compensation consultants. And they are all high-paying. But judged from any other perspective, the pay cap is an utter failure.
As the sportscasters are fond of saying: Let's go to the tape.
During 1994, the pay of the average American worker increased 2.9%, a rate that exactly paralleled the increase in prices during the year. In other words, the average American received no increase in real pay.
If the President's pay cap were working, one would expect to see an increase of less than 2.9% in the pay of senior executives who run large companies, because almost all were earning more than $1 million a year in total compensation when the new law took effect.
In evaluating whether this occurred, I looked at the year-over-year increases in pay for 155 CEOs of major companies, all of whom served in their jobs in both 1993 and '94. Here's what I found:
* In base salary, the average CEO earned $825,000 in 1994, up from $783,000 in 1993--for a year-over-year increase of 5.4%. Of the 155 companies, 25 paid their CEOs more than $1 million a year in base salary alone.
* In base salary and annual bonus, the average CEO earned $1.78 million in 1994, up from $1.6 million in 1993--for a year-over-year increase of 11%.
* Adding in payouts under long-term incentive plans and the present value of stock option grants, the average CEO earned $4.34 million in 1994, up from $3.75 million in 1993--for a year-over-year increase of 15.9%.
How can this be, in the face of Clinton's get-tough law on executive compensation?
Well, like so much of what emanates from Washington, the new law is a farce.
When the U.S. Treasury first signaled the likely shape of its regulations interpreting the law, it seemed as if they would have some real teeth.
The Treasury declared that the only way a company could pay an executive more than $1 million was to adopt a true pay-for-performance incentive plan and then have that plan approved by its shareholders. Moreover, the company would have to disclose so much information on the new incentive plan that your average shareholder, using a calculator, would be able to figure out just how much would be paid out to whom and under what precise levels of performance.
Nice try. But by the time the lobbyists jumped in, the final regulations emasculated the law's intent:
* The law was confined to public companies. Hence, a privately held corporation could pay its chief executive $100 million and get a full tax deduction.
* The law was confined to those public companies' five highest-paid executives. Hence, though Time Warner CEO Gerald Levin, for example, is covered, his subordinates, Robert Daly and Terry Semel, who run Warner Bros.--and who, it is rumored, earn substantially more than Levin--are not covered. The reason: Time Warner claims that Daly and Semel are not really executive officers of the parent company.
* The law says flat-out that any salary in excess of $1 million per year is not deductible. But the test applies not to when the salary is earned, but rather to when it is paid. A number of companies are paying their CEOs salaries in excess of $1 million--but deferring the excess until the day after the CEO retires. In the meantime, they are offering the CEO an out-of-this world interest rate, so that deferring salary becomes not a burden but a joy. And when the interest-inflated sum is paid out 24 hours after the CEO's retirement, all of it will be totally deductible by the company.
* The law says annual bonuses will escape the $1-million deduction limit if they are based on a formula. Bonuses cannot be raised above the amounts generated by the formula without losing the tax deduction. But they may be decreased at the board's discretion.
So here's what some boards have done: They have deliberately adopted a bonus formula that produces far more money than they would ever expect to pay--and then reduced the sum after the fact to what they would have paid had there been no government regulations at all.
A case in point is Salomon Bros. In past years, the brokerage firm never gave its CEO a bonus of more than a few million dollars. Now it has adopted a formula that can pay him as much as $24 million every year.
Struggling young parents know how to purchase shoes for their children: Buy the shoes a couple of sizes too big, stuff them with toilet paper and let the kids grow into them. Is Salomon's approach any different?
* The law denies a tax deduction on grants of so-called restricted stock above $1 million. This is the type of grant where the executive gets the shares totally free and, to earn them, is required only to breathe in and out 17 times a minute during some future period. But as with base salary, all a company has to do to get around this piece of the law is make sure that the restrictions don't lapse until the day after the CEO retires.
* The law makes it open season for stock option grants. Assuming the price which the executive must pay to exercise the option (the "strike price") is at least equal to the market price at the time of the grant, the company can grant the CEO millions of shares, and when he or she exercises them--before or after retirement--all the gain is deductible by the company.
Here, the Treasury has bought into the argument that stock options are the ultimate pay-for-performance vehicle. But consider a CEO who gets a 10-year option on 1 million shares with a strike price of $50 per share at a time when the market price of the stock is also $50 per share. Assume that the company pays no dividend and that the stock appreciates over the 10-year period at the same 7.5% annual rate as an investor could receive by purchasing Treasury bonds. After 10 years, the CEO exercises the option and realizes a pretax gain of $53 million. Every bit of that gain is deductible to the company, yet none of it can really be considered in the category of a reward for performance. After all, the investor could have enjoyed the same return totally free of risk.
Back in November, 1991, just after then-Gov. Clinton announced his candidacy, I received a call from him. He had read my just-released book, "In Search of Excess: The Overcompensation of American Executives," and graciously had written an endorsement for it.
We talked executive compensation for about 20 minutes. During that time, he brought up his preliminary intention to propose some sort of deduction cap on executive pay. I urged him not to do so. My thinking, then and now, was that executive compensation is a sort of adult game played between executives and shareholders--a game the government should stay out of, except for making sure that adequate disclosures are made. If shareholders want to curb what they perceive as excess, they have all the power they need: namely, their ability to vote out of office the entire board of directors and install a new one that will do their bidding. If shareholders are too stupid or lazy to step forward--as in a distressing number of excess-pay situations--they richly deserve their fate.
President Clinton didn't take my advice.
Instead, demonstrating his oft-repeated behavior of trying to please everyone, he sponsored a law that appears to have teeth but that, in reality, not only fails to curb pay but has contributed to a surge in pay that probably would not otherwise have occurred.
It is time for this bad piece of legislation to be repealed. Unfortunately, we'll end up losing some high-paying jobs--for securities attorneys, accountants and executive compensation consultants. But surely these talented folks can find something more useful to do.