« Happy Birthday, Montenegro | Main | A New Cold War? »

May 23, 2006

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c031153ef00d834c21d2f69e2

Listed below are links to weblogs that reference A link between options timing and taxes?:

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

JimOfMN

Thank you.
It was dumb to pass such a law. The consequences are worse than direct payment because the size of the prize is unknown up front.

These various incentives have also highlighted poor oversight by Boards of Directors AND the way certain CEOs showed the Board only a piece of the compensation package at a time preventing them from seeing the Whole picture

e.g.
Grasso of the NYSE
McGuire of United Health ($1.6 Billion options vested and about $400 million exercised.)


File this under:
Rules that-attempt-to-solve-a-problem gone bad.
or
Consequences of both:
Not Thinking something Through up front
AND
Not fixing when an error becomes apparent.

Other Examples:

1. Most attempts to stop the buying of favor in politics via ad hoc spending and donation rules.

2. Did an exception to CAFE mileage standards & the Luxury tax spawn the conversion of the rough-n-ready Jeep into the deluxe SUV industry?

3. The attempt by Nixon to collect tax from wealthy non-payers via the Alternative Minimum Tax that unfortunately did not index the threshold of taxation to either inflation or the Top X % of wealth.

Sean

So, to summarize: when a certain behavior is made illegal (or in this case non-deductible), people who want to engage in said behavior are more likely to break the law than if said behavior is legal.

Tautology much?

Todd Henderson

My point is not tautological at all.

The purported goal of section 162(m) of the IRC (the provision that limits deductibility) was to reduce total amounts of executive compensation. This section was passed during a flurry of academic, activist, and media criticism of the levels of executive pay. On this count, the law has been a failure. Pay levels rose dramatically in the wake of the passage. Why? The law also required disclosure of the exact amounts and form of pay. One reason often cited for this is that executives at rival firms now knew what others were making. The Lake Woebegone effect then kicked in, as all CEOs wanted to be paid more than average, and no firm wanted to be considered paying below average. The one-way ratchet here is obvious.

Because cash levels were now capped (for tax purposes), firms had every reason to pay more with non-cash, either perks or equity. Since performance-based pay (e.g., options) was specifically exempted, firms could be expected to pay more of this. The problem is, of course, that the use of options doesn't make sense in all cases or at levels necessary to attract and reward talent, especially given the heterogeneous preferences and wealth profiles of potential candidates. The law thus chose one form of compensation over another per se, without recognizing that this choice – the pay mix of cash and non-cash -- is something that cannot be made at a general level. It should be/needs to be a firm choice, not a government choice.

The law therefore distorts free choice, and, this is the key point, without a reasonable relation between the distortion and any sensible policy end. If the government passed a law capping salary, options, and retirement contributions (or any other form of monetary payment at $10 million per year), it isn't hard to imagine firms "paying" a lot more in perks to meet the exogenously set market wage for certain talent, which might exceed $10 million. If we observe this deception, which is merely designed to pay people what their value is, then we would conclude that this is a bad law. The market will set the wage, and the law should not encourage deception in how that wage is delivered.

So yes, we get more law breaking when things are made unlawful, but that is not my point. The point is that when the law is ill conceived, doesn't have the policy effect intended, and irrationally distorts behavior and encourages cheating, we can say that this law is a failure. Especially since cheating has a way of spreading from one area of behavior or firm culture to another.

* * *

As a post-script, I've talked to a few executive compensation lawyers that advise large firms, and they believe that most if not all of these cases involve the managers deceiving the board, not the company deceiving the government, so to speak. Thus this issue may be limited to a small number of cases. The theoretical point is still somewhat sound, and I believe that it does have the distorting effect described.

Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Working...
Your comment could not be posted. Error type:
Your comment has been saved. Comments are moderated and will not appear until approved by the author. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.

Working...

Post a comment

Comments are moderated, and will not appear until the author has approved them.