Tuesday, March 17, 2009

What happened last time we tried this 

So everyone is upset about the AIG bonuses. As an act of moral suasion, which is how I took it, President Obama's statement about "pursue every legal avenue" to prevent their payment is fine. I assumed when he spoke that the effort was understood to be futile, since Larry Summers had said the day before that they do not violate contracts "willy-nilly" and that this was not an avenue they wished to pursue.

More pressure has ensued, and now we have congresspersons contemplating a 100% tax on the bonuses. I'm not even sure that Mr. Liddy in sackcloth and ashes will slake the thirst for vengeance over payment on these contracts.

It is worth recalling however, as a reader wrote me today, that we have been here before. The Clinton Administration in its 1993 tax law change wanted to cap the amount of executive pay that could be deducted against income taxes. My correspondent writes:
There was also a loophole, a provision that said that Bonus Compensation was taxed differently than standard compensation. Bonus compensation under those provisions is fully deductible. That was the year when people like Michael Eisner of Disney got large bonuses for performance. Over time, Executive Compensation was shifted from Salary to Bonuses, and such provisions were written into Executive Contracts and those of other high performing employees. Presumably �Bonus Compensation� was to be tied to performance or certainly used as an incentive to get a star performer to move into a failing area of the business to help �right the ship�. Another point that is sometimes missed is that compensating someone with a bonus is being more responsible to the shareholders because this allows the company to structure its tote sheet in a way to reduce the overall corporate tax burden.

Now fast forward to the �Banking Crisis� and �Bailout Packages� and we have a sudden attack on �Bonus Payouts�. People who apparently don�t understand how business works or how to get top level performers to stick their careers out on the line are attacking people who get such rewards.
I think in fact they get it. One person reported to me that a client of his, who works for a large firm, was asked to move as a division president of a part of the firm that was struggling. The compensation agreement called for base salary and bonus, and that the bonus was to be as a minimum equal to base salary. That minimum was what the fellow received for two years; he got more in year three as the division turned around.

A couple years ago, as Democrats were taking office, Business Week discussed the distortion in the structure of compensation induced by the Clinton tax policy.
Bill Clinton had what he thought was a great idea to curb the soaring paychecks of the nation's executives. It was 1991, shortly after the launch of his Presidential campaign, and he had just read a best seller on corporate greed by compensation guru Graef Crystal.

Clinton's brainstorm: Use the tax code to curb excessive pay. Companies at the time were allowed to deduct all compensation to top executives. Clinton wanted to permit companies to write off amounts over $1 million only if executives hit specified performance goals. He called Crystal for his thoughts. "Utterly stupid," the consultant says he told the future President.
"We were trying to shame companies into changing their behavior," says former Clinton senior adviser Bruce Reed. "And companies have been shameless in ignoring what we did." Or perhaps just astute in exploiting the flimsiness of Section 162(m) of the IRS code, as the measure is formally known. Reed acknowledges that the Clinton team deliberately watered down the proposal to make it more palatable by, for example, not applying the performance requirement to the award of stock options.

This is part and parcel of a process we've referred to for years as "the regulatory dialectic." Often the dialectical process is technological in nature, and other times it's provided intentionally by the process, as it was in 1993. The underpayment of base salary was induced, in no small part, by previous fits of populist pique against executive compensation, and now that it produces an undesired outcome -- "bonuses" for executives at failing firms that aren't really bonuses at all. So now we'll respond with some new law hastily written and barely passable as not a bill of attainder, and what will happen? Probably something unexpected, and at some time in the future undesirable. Rinse and repeat.

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