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CEO Pay, Bananas, and Unintended Consequences

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July 02, 2019 | Barbara Baksa

CEO Pay, Bananas, and Unintended Consequences

I am an avid listener of podcasts, so a friend recently pointed out to me that there is a Planet Money episode titled “When CEO Pay Exploded” that looks into how today’s CEO pay packages got to today’s astronomical levels. The podcasters interview Don Delves of Willis Towers Watson, who many of you know from his presentations at past NASPP Conferences. It’s not that often that my world and the podcast world intersect, so I was pretty excited to listen to it.

The Chart

The podcast discusses a line graph that shows the trajectory of CEO pay since 1970. Up until the mid-1990s, CEO pay increased incrementally each year by a small by steady amount. Then, in the mid-1990s, the line graph makes a sudden vertical ascent. In the words of one of the podcasters, Jacob Goldstein, “CEO pay goes bananas!” (Listen to the podcast; you can hear the exclamation point.)

What Happened in the Mid-1990s?

Anyone want to take a guess? Well, one thing that happened is that the NASPP held it’s first Conference (don’t miss our 27th this year in New Orleans), but I don’t think that had any effect on the state of CEO pay. The thing that happened that caused CEO pay to skyrocket is that Section 162(m) was enacted. [The podcast blames 162(m) on President Clinton. While he definitely gets a large portion of the credit/blame, my recollection is that it was originally proposed under President Bush’s administration and that Congress certainly had a hand in it as well.]

And from there, you know the story. Section 162(m) limited corporate tax deductions for executive pay to $1 million per executive but carved out a giant loophole for performance-based pay (which the IRS interpreted to include stock options). And, at the time, APB 25 was still in effect, so companies didn’t have to recognize any expense for stock options. In retrospect, the results were probably predictable.

Unintended Consequences

Section 162(m) was enacted with the intention of curbing executive pay, by making it subject to performance and limiting corporate tax deductions for pay that wasn’t. The problem is that when executive pay packages are subject to risk, executives are going to negotiate for more pay. Even in today’s world, where all equity compensation results in an expense, vehicles like stock options and performance awards result in a lower grant date fair values, leading to larger grants (especially when companies take a value-based approach to determining grant size, as most do). The result is that when the targets are met or exceeded, the payouts are often outsized.

The Great Unknown

We are potentially at another juncture in executive pay. Companies have just started to disclose their CEO pay ratios (one factor the podcast didn’t discuss was the effect the executive compensation disclosures had on increasing executive pay by enabling executives to compare themselves to their peers) and Section 162(m) has just been amended to remove the exception for performance-based pay. It will be interesting to look back in thirty years to see if these changes have any impact or if they are just a blip in the CEO pay trajectory.

- Barbara

P.S.—Yes, that's right, there were a ton of boring images of line graphs that I could have used for this blog, but I used an image of bananas with googly eyes. What can I say; it's a holiday week. You're welcome.

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