Bailout Bill Would Use Tax Code to Cap Executive Pay

September 29, 2008

One part of the bailout proposal is a limit on the compensation of executives who work for bailed out companies. Participating companies who pay their executives more than $500,000 will face a tax penalty, by being unable to deduct the additional pay as an operating expense.

The provision is certainly understandable, as it seems perverse to heap extra pay on an executive who ran the company into the ground with dumb decisions. That the provision is limited only to those companies who participate in the rescue package, rather than a broad-based law applying to everyone, is perhaps a blessing (though adding tax law complexity). How wise is it, though, to apply it going forward?

These companies, post-bailout, will probably need the best talent they can get, and this law will essentially put them at a disadvantage to their competitors in executive compensation. Because the bill enforces the provision if a company even has one asset taken over, it may disincentivize participation by marginally troubled companies (which can be good or bad). Finally, the provision is populist in origin and has caused trouble before, as The Economist points out:

In the early years of the Clinton administration, Congress imposed a salary cap of $1m, beyond which firms faced a tax penalty. Pay rose, as one set of executives, beneath the cap, realised that they were "underpaid" and another set gained from an outpouring of creativity, as consultants invented myriad option schemes, perks and pension benefits to get around the limit. This only made it harder for shareholders to know who was getting what.

Cap the salary, and we just encourage different types of compensation and increase complexity.


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