April 11, 2008
Please Remove Your Cap…That Million Dollar Cap!
Section 162(m) of the Internal Revenue Code, the so-called “million dollar cap,” has been a failed tax law. It has been a cause of escalation in executive pay over time, rather than the deterrent it was intended to be.
When it was passed into law in 1993, it no doubt helped put performance on the table and stimulated an interest in the role of performance in executive pay. However, over time I have seen little practical impact on incentive plan design or incentive payout levels, and no end to the creative methods used to skirt (sorry, comply) with its requirements.
For most companies, Section 162(m) has resulted in creation of an additional faux incentive plan, with objective performance standards set at levels not easily missed, and handsomely rewarded when attained. The faux plan is the “umbrella” under which the actual bonus can still operate, usually unchanged. Discretion is maintained in determining payments in the actual plan, along with the tax deduction for the discretionary payment itself, so long as the actual payment does not exceed the outsized reward determined in the objective faux formula.
162(m) intended to penalize companies that exercised discretion in determining executive bonuses by ultimately making the bonus payment non-deductible. I believe that some discretion in determining executive annual incentives is necessary and a responsibility of management and Compensation Committees to exercise. And I think they should be accountable for this exercise of discretion, but accountable to shareholders, not the IRS.
The advent of the new proxy disclosure rules and the SEC staff’s push to have companies disclose how they exercise discretion and what factors they considered in determining executive bonuses now provides a process of public disclosure and accountability for the exercise of discretion in executive incentives. Today, 162(m) looms more as a potential “gotcha” if companies are forthright in their CD&A in disclosure of their exercise of discretion.
Encourage legislators who have spoken out against Section 162(m), to take the difficult political steps needed to remove this particular cap and help shareholders get the type of disclosure they deserve. You can contact:
– Representative Barney Frank (D-MA)
– Senator Charles Grassley (D-IA)
– Senate Finance Committee Chairman Max Baucus
– Eric Marquardt