Thursday, January 26, 2006

Professor Bainbridge says the 1994 tax bill that barred companies from taking a tax deduction for compensation in excess of $1 million a year led, in some cases, to management committing financial fraud while pursuing the incentive-based compensation that came into favor as a result of the tax bill...

I've got to disagree.... not with the fact that executives committed fraud chasing higher stock prices, but with the idea that companies adopted these incentive plans in response to the tax bill. True, the bill exempted such incentive based plans from the $1 million limit, but the idea of incentive based compensation for managers had been building for years. As a response to many of the hostile takeovers of the 1980s that were driven by claims that management had no stake in the success of the business, and, as such, had no reason to take action to boost the stock price, many companies did adopt incentive based plans for their management.

And let's not overstate the impact of losing the tax deduction for the 'excess compensation'. Most companies that are large and profitable enough to be paying their executives compensation in excess of $1 million a year aren't that concerned about the overall minimal impact of losing a tax deduction. To illustrate, take a Fortune 500 company that awarded its CEO a $2 million (non-incentive based) pay package. The company would have lost a $1 million tax deduction, which at standard rates, would have cost the company about $400,000.... which is chump change to a Fortune 500 company.

Most companies don't let the tax return drive their business model. For example, Travel and Entertainment expenses are not fully deductible... yet companies still wine and dine customers and clients... not because they like 'losing' deductions, but because they think the expenditure is well worth the cost.

And so it would have been for companies losing the tax deduction for a percentage of their 'excess' executive compensation... to corporate boards, the expenditure was well worth it... and, if they lost a deduction, they figured they were still ahead.