In Defense of the U.S. Taxpayer: End Deferred Compensation and Its Tax Subsidy 16 comments
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In my earlier post on bailed-out banker pay, I argued that we need a simplified compensation regime that more closely aligns corporate managements with their shareholders:
The whole issue of executive compensation - both on and off Wall Street - needs a redo. I have a hard time with the concept of large single-year cash payouts. Senior executives should be paid for value creation over time. Just like hedge fund managers. If you want to be assessed on creating long-term value, which should be every Board's goal, than executive compensation needs to fit this mold. Same with hedge fund managers. With performance comes payout, and if performance is long-term then payout should be long-term as well. With hedge funds implementation would be easy; only pay management fees currently and pay performance fees either based upon P&L realization (as opposed to P&L realized and unrealized that is the model for most) or over a time horizon that approximately matches holding period (which could be 3-5 years for certain long-term value managers with concentrated positions).
With corporations it is somewhat harder, as the concepts of realization and holding period are difficult to apply. That said, long-term stock options with long-dated cliff vesting comes pretty close to achieving this objective. I like the idea of senior executives holding 10 year options with 5 year cliff vesting (meaning that they fully vest only after 5 years; if they resign or get fired before 5 years they leave it all behind). This, I believe, closely aligns senior management with stockholders, and specifically avoids quarterly maniupulation that is the hallmark of large option grants that vest on a short-dated schedule. But this only works if almost all of executive compensation is in these options, such that the cash portion isn't so large as to incentivize bad behavior and the quarterly earnings manipulation mentioned above.
The hallmarks of my plan are transparency, simplicity, fairness and alignment of motives. Successful executives get extremely well-paid, as they should. But they don't gain material wealth for simply showing up. They've got to perform. And the way to cement alignment of motives is by tying their prospects to long-term, not short-term stock-based performance, and to have this comprise the vast majority of their total compensation (say 80-90% of total comp). But this only solves part of the problem.
The recent revelation concerning the magnitude of deferred compensation liabilities faced by the largest Wall Street firms raises two important questions:
- Why do we have these deferred compensation plans in the first place?
- Why are the U.S. taxpayers injecting money into institutions and effectively protecting these unsecured liabilities?
Deferred compensation plans exist as yet just another perk of being a member of senior management, not just of banks and Wall Street firms but of many corporations as well. I earn my money, I get my bonus, but because I don't need all that wealth to live right now I can defer it and pay taxes in future value dollars instead of present value dollars. Not all deferred compensation is in company stock: executives can defer cash bonus portions as well, and often have the ability to invest those sums in third-party mutual funds, firm-sponsored private equity and venture capital funds and other alternative assets.
The trick to make these plans work, however, is that the accounts are technically not guaranteed, e.g., they are unsecured liabilities of a separate corporate holding company that administers the plan. So, in the case of Lehman, all that deferred compensation is gone, both cash and stock, because of the bankruptcy and the magnitude of senior claims on liquidated assets. But in the case of Bear Stearns, JP Morgan (JPM) in its role as acquirer is standing behind the deferred compensation obligations.
But what about all those banks and Wall Street firms that have received massive capital injections under TARP, firms that may or may not have survived without Government (read: U.S. taxpayer) assistance? A good chunk of TARP funds are effectively backstopping these liabilities. Is this right and fair? I'd say not. Prior to TARP injection of $25 billion, what do you think Citigroup's (C) deferred compensation plans would have traded at, as cents on the dollar? I'm not sure, but I know they would have traded at a steep discount, a far steeper discount than after the Treasury showered it with capital. Was this transfer of value from the U.S. taxpayer to Citigroup senior management intended? I certainly hope not. Which is one of the fundamental problems I have with TARP in the first place. It is, at least temporarily, bailing out the senior executives and shareholders of sick firms. This should not have been the intention of Paulson, Bernanke et al. Regardless, this is one of those unintended consequences that is both wrong for long-term shareholder value and as a matter of fairness to those U.S. taxpayer. And I'm really not happy about it.
There is no reason to have these plans. Just pay executives what they are worth, structure their compensation to be aligned with shareholders and get on with it. Forget complex deferred compensation provisions that chew up tax revenues and are, frankly, neither fair nor necessary. Let's get rid of those excessive golden parachutes; they're not needed, either. Let's focus on optimizing executive pay, narrowly defined (cash plus long-term stock awards) and eliminating all the perks and benefits that have long been opaque and, frankly, costly and unfair to shareholders and other employees. And especially at a time when the U.S. taxpayer is propping up much of the U.S. financial sector, these plans should not be subsidized by their dollars. It is ethically wrong, morally bankrupt and is yet another scar on a program that is burdening our country for generations. That is a topic for another post.
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This article has 16 comments:
if you do not do that, by the end of the executives contract he will have less and less incentive to be forward looking.
because our system is geared to short term profits at the expense of long term profits - we continue to have myopic business decisions.
> jack
"... Was this transfer of value from the U.S. taxpayer to Citigroup senior management intended?"
I think it was, is, and will continue to be. As a function of group survival the bankers and others at the very top of the financial order have quietly, until now, are insuring their survival. Unfortunately it is a win loose scenario, un-democratic and pathetically abusive to not only honor and nobility, but these people are just plain old fancy criminals.
The tax "subsidy" of deferred compensation is a chimera. Corporate and individual rates are essentially the same. A corporation cannot deduct deferred compensation until it is paid. In the year of deferal, the executive des not pay tax (but the corporation pays tax on the deferred amoutn). It's a wash for the Treasury.
I'm in favor of eliminating deferred compensation, but it's more for "fairness" rather than Treasury collections. Under Dept. of Labor rules, it's not allowed to defer compensation unless you are a "top hat" employee. Theoretically, that prevents average people from subjecting deferred compensation to the risk of corporate bankruptcy. In the real world, it gives the "top hats" exclusive rights to a tax planning technique not available to the masses.
LordDarley
The suggestion that equity grants be
The first two bribe the third. Campaign contributions (including indirectly, like those free plane rides) go overwhelmingly to incumbents, who typically are returned to office at about a 95% rate. Both parties are complicit. In fact, under our current system, you simply can't get elected to public office, and then re-elected, without massive campaign contributions. Granted not all of those come from the financial/corporate mafia, but enough do to give them effective control of our government.
Politicians are going to dance to the tune of those who keep them in office. We need an election system that is based on "one person, one vote" instead of "one dollar, one vote". All elections should be publicly financed (and non-partisan to boot). Public officials should be barred from accepting ANYTHING of value from anyone other than their employer, the American people. If you don't want your tax dollars to pay for political campaigns, then you are handing the system over to big money, which is how we have gotten where we are today.
The title of this article is misleading as it implies some benefit in the tax code for deferred compensation, as opposed to the taxpayer subsidy inherent in TARP. Nothing could be further from the truth. Deferred comp is NOT like a 401K. Nothing is funded and there is no protection for these liabilities in a bankruptcy. There are MANY instances of corporate executives who did great things for their companies, and retired with a nice, not extravagant, non-qualified pension benefit, only to see the company end up in bankruptcy 5 or 10 years later, as a result of subsequent managments actions, and their pension benefit totally gone.
There is nothing to tax as nothing has been paid. And the companies receive no deduction for it until it is paid. In some cases, it may not ever be paid. Company goes down the tube and these plans become unsecured creditors.
however, it is interesting to note that the GSE run by Barney Frank has stated that they will honor the defered compensation agreements for their executives. The WSJ article on this issue quoted the FRE spokesperson as stating the necessity of honoring the deferred pay packages for the managements that helped destroy the companies. Where will Barney land on that issue? Wipe them out along with the preferred holders is my solution. BTW, they were GUARANTEED a 9%+ return on the deferred money.
The executive steals.
He writes laws to define executive compensation as not-stealing.
Then he steals some more.
The other employees will, in time, write laws to define employee compensation.
all in all I agree with the author. let me get that out right now.
what I want to ask is where did the problem stem from that caused Lehmans to go under? wasn't it poor lending practices in the entire banking industry in general? why were the practices so bad? why was the money so easy to come by in the first place? and what caused that event?
when we lowered the cost of the money to recover the economy from a set of planes crashing in to the WTC and Pentagon, why did it lower the cost of money for housing and real estate projects too? shouldn't it have only lowered the cost of money for businesses and corporations to stimulate economic development in the effected areas? entities that create some overall economic value not just real estate rental complexes for private investors portfolio. (no matter how personally fond I am of that idea myself lol)
I'm not assigning blame. im asking about shoulds. what should have happened in these scenarios? Maybe some of this is just fallout from a single event 7 years and we are just looking at the aftermath yelling out about mess to clean up instead of thinking about how to stop it from occuring again in the future.
I don't have all the answers, infact I hardly have any clue of what is really going on with the banks.
but, perhaps this was a 25B reason why we should just take a couple minutes to just sit and reflect and just try to understand what happened first?
Right now if that same event happened are measures in place to stop the present day situation?
- I am all up for any reflections or ideas or notes worthy, I just dont have any long term answers myself. quite frankly I just dont know enough about the laws to offer any ideas. do you?
If someone is so bad that we have to pay them to leave why the hell are they being hired in the first place?
I don't care what your risk is in leaving your position, if you want to be paid for your future loss in earnings by leaving current job or by the unpredictability of future paycheck at the job your going to, work that crap out before you sign on the dotted line.
seriously, get your "golden parachute" up front, no backend deals. I would imagine that alone would stop a big chunk of the problem. Especially if board members saw that in their first year or (perhaps first 2 years) that the executives weren't justify the sign on bonus, they would get them out of there in a heart beat.
I also don't know if I can agree with trying to tie their paycheck to a number based on the net value generated. My reason, is because there are alot of ways to measure value. and what do you when your in a recession and they are only down 5% but the market is down 20%? then they are UP 15% of the rest of the market but are they to be punished for this? I think it is things like that cause to many problems with tieing paychecks to value.
But, if someone can prove that they really ARE doing something to justify that paycheck they are receiving then more power to them. wish I was as productive as that.
sure.
speaking of executive pay, if you have a better idea. you impliment it. remember its YOUR country, I just live in it.
if you start playing with peoples deferred comp you start changing their plans for the future that they have already invested in.
; )
Bankruptcy would have placed the deferred compensation arrangements into another debt of the company they worked for.
George Potts