Attempts to limit CEO pay have yet to succeed
There’s one thing that angry lawmakers and their constituents agree about the Wall Street bailout being crafted by Congress: Executives at teetering companies the government helps steady shouldn’t walk away with millions of taxpayer dollars stuffed in their pockets.
But Washington has tried before to limit the compensation of chief executives. And Wall Street has found ways around it.
Corporate governance experts said they wouldn’t be surprised if the armies of lawyers, accountants and executive compensation consultants employed by major corporations again ferret out loopholes in whatever restrictions Congress crafts.
“I’m sure there are probably people working on that right now,” said Paul Hodgson, senior research associate for the Corporate Library, a corporate governance research firm. “Undoubtedly, there will be a way around it. There are too many smart lawyers out there.”
Although no agreement on the proposed $700-billion bailout had been reached as of late Thursday, House and Senate negotiators earlier in the day said they had reached agreement on several principles. The first one dealt with the salaries of CEOs whose struggling companies would get the money: The Treasury secretary would “set standards to prevent excessive or inappropriate executive compensation for participating companies.”
There were no details. But a draft proposal this week from Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, called for a prohibition on severance to senior executives for two years after they participated in a government program to buy up debt-laden mortgage-backed securities, and a provision requiring executives to refund any bonuses or incentives that were paid based on overstated financial results.
President Bush on Wednesday said any bailout “should make certain that failed executives do not receive a windfall from your tax dollars.”
But the history of attempts by lawmakers to corral CEO pay has shown it’s difficult to accomplish -- and sometimes can have unintended consequences.
In 1984, Congress tried to limit executive severance by adding what was known as the “golden parachute” provision to the tax code. It changed Internal Revenue Services rules so that any payment more than 2.99 times an executive’s annual salary was subject to a 20% excise tax.
At the time, most companies provided a severance of one year’s salary, said Bill Coleman, chief compensation officer for Salary.com, which helps companies set employee salaries based on their performance. But companies interpreted the rules to mean that anything up to three times the salary was permissible, and severance packages began rising to that level, he said.
“It was intended to be the ridiculous maximum possible anybody could pay, but it eventually became the benchmark,” Coleman said.
In addition, companies that exceeded the severance level for an employee simply provided a bonus payment to cover additional income taxes, a practice known as grossing up.
“It did not have the effect of reducing severance pay,” Hodgson said. “It had the effect of increasing it.”
Seven years later, when Bill Clinton was running for president, he seized on executive salaries as a campaign issue. Graef Crystal, a former executive compensation consultant and author of six books on the subject, said Clinton called him with an idea to limit a company’s ability to deduct more than $1 million in salary for top executives from their taxes. Crystal said he told Clinton it wouldn’t work.
In fact, it may have backfired.
The resulting law, which was passed in 1993, is widely believed to have led to the explosion in stock options for executives as companies sought ways to avoid the salary restriction. Total CEO compensation surged through the rest of the decade, to 300 times the average worker’s salary in 2000 from 100 times the average in 1993, according to the Economic Policy Institute, a liberal think tank.
According to another advocacy group, United for a Fair Economy, the average annual CEO pay for top companies in 2007 was $10.5 million, or 344 times that of the average U.S. worker.
“The people on Wall Street may be greedy . . . but they’re very smart,” Crystal said. “I’m sure the consultants can hardly wait to get their hands on these restrictions and figure their way around them.”