{"id":3398,"date":"2015-01-23T15:10:15","date_gmt":"2015-01-23T23:10:15","guid":{"rendered":"http:\/\/hodakvalue.com\/blog\/?p=3398"},"modified":"2015-01-23T15:18:38","modified_gmt":"2015-01-23T23:18:38","slug":"squeezing-the-balloon-once-more-and-expecting-a-different-outcome","status":"publish","type":"post","link":"http:\/\/hodakvalue.com\/blog\/squeezing-the-balloon-once-more-and-expecting-a-different-outcome\/","title":{"rendered":"Squeezing the Balloon Once More, and Expecting a Different Outcome"},"content":{"rendered":"

Americans seemed, at least for now, to have reached their saturation point on direct wealth redistribution. So for those who still feel we have more redistribution to do, they are trying via\u00a0the tax code. \u00a0A Democratic congressman has proposed to penalize executive pay\u00a0if the company \u201cfails [the] test of pay fairness.<\/a>”\u00a0 Specifically, if a public company fails to raise the average pay of its workers making less than $115,000 by a percentage equal to the overall US growth in productivity plus inflation, the government will eliminate the deductibility of top executive compensation above $1 million. What could go wrong?<\/p>\n

\"\"Well, let\u2019s look at a brief history of attempts to use the tax code as a vehicle for social engineering.<\/p>\n

We begin with the tax on \u201cgolden parachute\u201d payments in 1986. Executives being ousted in takeovers got big payouts, while many of the workers left behind got laid off. Very unfair. So the government imposed an excise tax on those \u201cparachute payments\u201d when they became \u201cexcessive.\u201d They felt that such a tax would either limit the compensation or limit the deleterious M&A activity. How did that work? \u00a0Employment agreements began to proliferate for executives stipulating that shareholders pay the excise tax should it be triggered. \u00a0There were good business reasons for doing this. Given that this tax reimbursement was itself taxable, and the shareholders would be on the hook for that, too, the tax policy basically transferred a chunk of change from corporate treasuries to the U.S. Treasury. It didn’t affect the M&A activity. \u00a0And it left overall compensation largely untouched.<\/p>\n

When the corporate critics saw what was happening with these excise tax “gross-ups,” they urged new policies to prevent these payments, or to shoulder them back onto executives as Congress had intended. And many corporations did implement these policies, and their executives successfully negotiated for other offsets, and the ridiculous complications that ensued now account for several pages in employment agreements whose net effect is close to nothing on overall pay, but significant expenses for shareholders.<\/p>\n

In 1992, when $1 million CEO salaries were becoming the norm while the average American was experiencing a recession (very unfair), Congress put a cap on the deductibility of top executive pay above $1 million, with\u00a0an exception for “performance-based pay”\u2014the so-called \u00a7162m provision. The reaction to that tax, and the reaction to that reaction and so forth are now responsible for most\u00a0of the harrowing complexity that executive compensation has become. Institutional investors, tasked with deciphering 30+ pages of pay disclosure, are crying out \u201cwhy does it have to be so damn complicated!\u201d \u00a0They can thank \u00a7162m. And the net effect on executive pay, on a size-adjusted, risk-adjusted basis, is close to nil. But shareholders\u2019 cost of compensation is now much higher.<\/p>\n

The initial corporate reactions to the law may have been unintended, but they were not unpredictable. \u00a0If you assume that the pay of the people at the top is arbitrarily determined, then simple-minded laws like 162m are bound to produce some surprises. \u00a0If you assume that executive pay, like all pay in the private sector, is the product of negotiations in a market for talent, and see ham-handed laws like 162m get implemented, you get exactly what you would anticipate. \u00a0When the left saw the logical impact of 162m, i.e., the shift of all pay increases to \u201cperformance-based\u201d compensation, they said, \u201cThose rascally corporations are getting around the intent of the law!\u201d \u00a0They proceeded to push for additional rules to contain executive \u201cgreed\u201d or \u201cboard capture\u201d based on their original assumption about the arbitrariness of executive pay, triggering the next step in the cycle.<\/p>\n

Democrats are now similarly assuming that all <\/em>pay is arbitrarily, consistent with long-held union attitudes about compensation. \u00a0So, they expect that this law will either force shareholders to give raises to nearly everyone in the company in most years, or they will pay even higher taxes on their executive pay. \u00a0The former outcome will make sense if pay is arbitrary. \u00a0The latter outcome is just punishing corporations for having high earners.<\/p>\n

So, what are the odds that public companies will\u00a0raise everyone’s pay, regardless of how their company or sector is doing, based purely on a long-term, national average of productivity gains plus two percent? \u00a0Well, the question practically answers itself. \u00a0It’s far less costly for shareholders to eat the foregone tax deductions of executive pay. \u00a0The proponents of the bill would be fine with that. \u00a0The effect on CEO pay will be nil, but corporations will pay more, making this a populist way of increasing corporate income taxes. \u00a0But what if some corporations actually plot for a way to avoid having to pay that extra tax? \u00a0The best way to do that would be to aggressively cut pay for their rank-and-file in bad times, when they can get away with it, so the company has an opportunity to make up for it with tax-compliant raises in good times. \u00a0In other words, logical conclusion of such a law will be to leave top executive pay untouched, but to more pay variation, and possibly declines, in average worker pay over time. \u00a0Again, I don\u2019t think that would happen at more than a handful of companies, but wherever it does happen, the left will be screaming about the unfairness of it, and proposing new restrictions on how companies can pay their people.<\/p>\n

And the cycle will begin again.<\/p>\n","protected":false},"excerpt":{"rendered":"

Americans seemed, at least for now, to have reached their saturation point on direct wealth redistribution. So for those who still feel we have more redistribution to do, they are trying via\u00a0the tax code. \u00a0A Democratic congressman has proposed to penalize executive pay\u00a0if the company \u201cfails [the] test of pay fairness.”\u00a0 Specifically, if a public […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[5,9],"tags":[],"class_list":["post-3398","post","type-post","status-publish","format-standard","hentry","category-executive-compensation","category-unintended-consequences"],"_links":{"self":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3398","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/comments?post=3398"}],"version-history":[{"count":4,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3398\/revisions"}],"predecessor-version":[{"id":3406,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3398\/revisions\/3406"}],"wp:attachment":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/media?parent=3398"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/categories?post=3398"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/tags?post=3398"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}