Proposal Aims to Eliminate Tax Break Linked to Performance-Based Pay for Executives

Federal lawmakers have set their sights on executive pay once again with the tax-code overhaul, which could make it more expensive to hire and retain management talent.

The House bill, released Thursday, proposes cutting a Clinton-era tax break aimed at reining in salaries and tying top corporate officers' compensation to performance. Current law caps the amount companies can deduct from their taxes for executive compensation at $1 million. However, deductions in excess of $1 million are allowed for certain types of compensation, most notably performance-based pay.

The current norms "have resulted in a shift away from cash compensation paid to senior executives in favor of stock options and other forms of performance pay," the document said. "This shift has led to perverse consequences as some executives focus on -- and could, in rare cases, manipulate -- quarterly results...rather than on the long-term success of the company."

The proposed changes would eliminate the tax break linked to performance-based pay for senior executives, raising some $9.3 billion in additional tax revenue over the next decade, according to a House summary of the tax proposal.

That is a drop in the bucket compared with the $1.46 trillion the government would lose by reducing the overall corporate tax rate to 20% from the current 35%.

"It seems to me that the government is giving to businesses on one hand with a lower tax rate but taking some of it back with removing some of these deductions," said Steven Hall Sr., founding partner and managing director of compensation consultancy Steven Hall & Partners.

Critics of the proposed move say regulating senior executive pay has backfired in the past and done little to stop the steady climb of their compensation packages.

"The best way the government can fix executive compensation is to stop trying to fix it," said Kevin Murphy, a finance professor at the University of Southern California's Marshall School of Business. "All attempts to regulate executive pay through the tax system have generated negative consequences that far outweigh any benefits."

A combination of tax deductibility and shareholder feedback have led compensation to lean more heavily on performance-contingent equity through the years, according to Matthew Goforth, senior governance adviser of compensation-research firm Equilar Inc.

From 2006 to 2016, the median total compensation of a large-cap company CEO increased by an inflation-adjusted 25%, while average worker pay rose 6%, according to Equilar.

In the last five years, median stock-based compensation for the same cohort of CEOs jumped 44%, while salaries increased about 10%.

Some analysts say the new changes might yield unintended consequences as compensation packages adapt to the new rules. Businesses could start paying their senior executives higher salaries, since they no longer lose a tax break for cash salaries exceeding $1 million a year.

"Companies will be more willing to move salaries to the...appropriate level, given the overall compensation package for a CEO," said Irv Becker, vice chairman for executive pay and governance at Hay Group, a unit of recruiters Korn Ferry International.

Other executive-compensation specialists said corporate boards would continue to look for ways to link compensation with performance.

"It's really hard to say a change in the tax code will really change what companies have been doing for the last several years," said Steve Seelig, senior regulatory adviser for executive compensation at Willis Towers Watson, a professional services firm.

Boards now place more focus on pay for performance because "that's what shareholders are looking for," Mr. Seelig said.

Under the 2010 Dodd-Frank Act, investors can express disapproval about high pay packages for top corporate officers through "say-on-pay" votes. Boards fear a "thumbs down" on such referendums -- which are nonbinding -- because they typically reflect deeper investor discontent.

The loss of the tax break may prompt a few companies to stop using stock options, Mr. Seelig said, but he believes competitive pressures play a bigger role. "Peer practices are very, very strong in the world of executive pay," he said.

Many companies already have moved away from options in favor of restricted shares tied closely to performance, said James D.C. Barrall, an executive-pay specialist who is of counsel at Latham & Watkins LLP. He also advises board compensation committees.

Yet, longtime critics of executive pay welcome the tax break's possible demise. "It has had less than no effect on tightening the links between pay and performance," said Nell Minow, vice chair of ValueEdge Advisors, which promotes good governance and shareholder rights. The break "had the exact opposite effect of what it was intended to do."

Write to Ezequiel Minaya at and Joann S. Lublin at

(END) Dow Jones Newswires

November 02, 2017 18:06 ET (22:06 GMT)