As the Presidential election year swings into high gear, tax deductions for executive compensation are expected to be an area of debate, and a joint report released this week by The Washington Post and ProPublica under the title "The Executive Pay Cap That Backfired" asserts that Section 162(m) of the tax code is not a primary factor in how companies compensate senior executives. The study, conducted by S&P Global Market Intelligence, compared the executive compensation structures and amounts for 40 of the top 50 S&P 500 companies in 1992 and in 2014. (The other 10 companies either were not publicly traded in in 1992 or did not exist). The study showed the following:
- Not surprisingly, the number of companies that had nondeductible compensation under section 162(m) (salary, bonuses not tied to objective performance factors and restricted stock) above a total of $1 million (the 162(m) deductibility limit for the covered named executive officers) had increased from 35% to 95% between 1992 and 2004.
- Nondeductible compensation per executive rose from $1.1 million to $8.2 million, an increase of 650%, while deductible compensation rose from $950,000 to $4.4 million, an increase of around 350%. This led report author Allan Sloan to comment “It turns out losing deductibility isn’t all that big a deal to companies.”
There are some anomalies to the study. The most significant are that the numbers are averages and that while the 1992 aggregate pay numbers include the CEO and the four most highly compensated named executive officers, presumably including the CFO, the 2014 numbers exclude the CFO, as the result of the 2006 changes in the SEC definition of named executive officers. Thus, the comparison is not apples to apples. The study also does not address the fact that stock option expensing took effect in 2004, changing compensation approaches.
The findings above contradict a recent study by the American Enterprise Institute which found that the tax benefit of deferred compensation relative to cash increased more than 14 times from $3.67 to $51.86 per $100 after the adoption of IRS Code Section 162(m) in 1992. As a result of the tax benefits, the study concludes, the use of deferred compensation and particularly the use of stock options as compensation, has increased dramatically while other forms of compensation, like restricted stock, which do not provide the same benefits, have not seen the same emphasis. The study finds in sum that Section 162(m) has led to an increase in executive pay as well as deferrals, and thus has "economically significant implications for government revenue."
The repeal of Section 162(m) has long been floated as a revenue raising opportunity in any tax reform effort as well as a target to off-set social spending initiatives. The conclusions included in the Post-ProPublica and AEI studies only increase the likelihood that 162(m) will be targeted in a tax reform effort.