February 8, 2019
Will Non-Deductible CEO Pay Anger Shareholders?
– Liz Dunshee
Nobody expects the repeal of Section 162(m)’s “performance-based” exception to cause companies to limit CEO pay to less than $1 million. This research from two economists finds as much when looking at tax deduction limits in the health insurance industry imposed by the Affordable Care Act. Here’s an excerpt:
The ACA prevented insurers from deducting more than $500,000 of a CEO’s pay from their profits for tax purposes. This meant that instead of CEO pay costing the firm 65 cents on the dollar (the tax rate was 35 percent at the time), it cost them 100 cents on the dollar, effectively raising the cost of a marginal dollar of CEO pay by more than 50 percent.
If health insurers are setting the pay equal to the value the CEO adds to the shareholders, the increased cost of pay to the company from the loss of tax deductibility should have unambiguously had the effect of lowering CEO pay, after controlling for other factors. We ran a large number of regressions, controlling for increase in revenues, profits, share prices, and other factors that could plausibly affect pay.
It was a small sample size – but in none of them did we find any evidence that CEO pay in the health insurance industry had been lowered by this provision in the ACA. This would seem to support the view that CEO pay does not bear any relationship to the returns CEOs produce for shareholders.
That last sentence is…disturbing? Incorrect? I’m not sure. You would think shareholders would care about lower returns – but rightly or wrongly, I think they’re more likely to blame the government than CEO pay for any reduction in earnings that’s caused by changes to the Internal Revenue Code. But there is an outside chance that shareholders will do more to limit CEO pay – e.g. by voting down “say-on-pay” or voting against directors – now that they bear the full cost. Here’s what the economists concluded:
In order to limit CEO pay it may be necessary to alter the rules of corporate governance in ways that increase the power of shareholders over the CEO.