The Executive Compensation Controversy - Fondazione Rodolfo ...

THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSIS• Executives were required to hold stock acquired through option exercises for three years(rather than six months under the 1950 Act) in order to be taxed at the lower capital gainsrate.• Exercise prices to be set at no less than 100% (rather than 85% under the 1950 Act) of thegrant-date market prices.• The maximum option term was reduced from ten years to five years.• Repricing of options were prohibited.To distinguish options meeting these new requirements from restricted options grantedunder the Revenue Act of 1950 provisions, the 1964 Act referred to new grants as “qualifiedstock options” rather than restricted stock options.Finally (but perhaps most importantly), the 1964 law reduced the top marginal tax rateon ordinary income from 91% to 70%, which significantly reduced the attractiveness ofqualified options over “non-qualified stock options” (in which the gains upon exercise aretaxed as ordinary income for the recipient, and deductible as a compensation expense to thecompany cash compensation). Figure 2.7 provides a historical comparison of the taxadvantages of restricted or qualified stock options relative to cash compensation or “nonqualifiedstock options.” As a result of the 1964 tax law, the after-tax cost to investors ofconveying an after-tax Euro to the CEO in cash compensation fell from €5.56 to €1.73,while the cost of conveying an after-tax dollar in restricted or qualified stock options (taxedas capital gains) remained at €1.33.-29-