The Executive Compensation Controversy - Fondazione Rodolfo ...

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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISExecutives Institute, the Pharmaceutical Manufacturer’ Association, and the NationalVenture Capital Association. 43Ultimately, and without fanfare, FASB tabled its 1986 proposal before submitting anexposure draft. However, the proposal was revived in the early 1990s as CEO pay once againbecame highly controversial. In late 1991, Senator Carl Levin attempted to bypass FASB byintroducing legislation that would require companies to take a charge to their earnings toreflect the cost of option compensation packages; the bill also directed the SEC to requiremore disclosure for stock option arrangements in company proxy statements. AlthoughLevin’s bill was ultimately shelved, it provided pressure for renewed FASB focus on optionexpensing.In April 1992, FASB voted 7-0 to endorse an accounting charge for options, and issueda formal proposal in 1993. The proposal created a storm of criticism among businessexecutives, high-tech companies, accountants, compensation consultants, the Secretary of theTreasury, and shareholder groups. 44 Even President Clinton, usually a critic of high executivepay, waded into the debate in December, expressing that “it would be unfortunate if FASB’sproposal inadvertently undermined the competitiveness of some of America’s mostpromising high-tech companies.” 45 In March 1994, FASB held public hearings on the issue.In the aftermath of the overwhelmingly negative response, FASB announced it was delayingthe proposed accounting change by at least a year, and in December it dropped the proposal.In 1995, the FASB issued a compromise rule, FAS123, which recommended but did notrequire that companies expense the “fair market value” of options granted (using Black-Scholes or a similar valuation methodology). However, while FASB allowed firms tocontinue reporting under APB Opinion No. 25, it imposed the additional requirement that thevalue of the option grant would be disclosed in a footnote to the financial statements.43 See, for example, Rudnitsky and Green, “Options Are Free, Aren’t They?,” Forbes, (August 26, 1985);Gupta and Berton, “Start-up Firms Fear Change in Accounting,” Wall Street Journal (June 23, 1986); Fisher,“Option Proposal Criticized,” New York Times (December 27, 1986); Eckhouse, “Tech Firms’ Study:Accounting Rule Attacked,” San Francisco Chronicle (April 10, 1987)44 See, for example, Berton, “Business chiefs try to derail proposal on stock options,” Wall Street Journal(February 5, 1992); Harlan and Berton, “Accounting Firms, Investors Criticize Proposal on Executives’ StockOptions,” “ Wall Street Journal (February 19, 1992); “Bentsen Opposes FASB On Reporting Stock Options,”Wall Street Journal (April 7, 1993); “Clinton Enters Debate Over How Companies Reckon Stock Options,”Wall Street Journal (December 23, 1993); Berton, “Accounting Rule-Making Board’s Proposal Draws Fire,”Wall Street Journal (January 5, 1994); Harlan, “High Anxiety: Accounting Proposal Stirs Unusual Uproar InExecutive Suites,” Wall Street Journal (March 7, 1994).45 “Clinton Enters Debate Over How Companies Reckon Stock Options,” Wall Street Journal (December 23,1993).-33-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISPredictably, only a handful of companies adopted FASB’s recommended approach. As we’lldiscuss below, it wasn’t until the accounting scandals in the early 2000s that firmsvoluntarily began to expense their option grants.2.4.3. The $1 Million Deductibility Cap and the Stock Option ExplosionCorporations in the USA are generally allowed to deduct from income all “reasonable”compensation expenses. In the 1992 USA presidential campaign, candidate Bill Clintonpromised to “end the practice of allowing companies to take unlimited tax deductions forexcessive executive pay” by defining compensation exceeding $1 million as unreasonableand therefore not deductible. Concerns about the loss of deductibility following the electioncontributed to an unprecedented rush to exercise options before the end of the 1992 calendaryear, as companies urged their employees to exercise their options while the company couldstill deduct the gain from the exercise as a compensation expense. 46 In anticipation of theloss of deductibility, large investment banks accelerated their 1992 bonuses so that theywould be paid in 1992 rather in 1993. In addition, several publicly traded Wall Street firms,including Merrill Lynch, Morgan Stanley, and Bear Stearns, announced that they wereconsider returning to a private partnership structure if President-elect Clinton’s plan wereimplemented. 47By February 1993, President Clinton backtracked on the idea of making allcompensation above $1 million unreasonable and therefore non-deductible, suggesting thatonly pay “unrelated to the productivity of the enterprise” was unreasonable. 48 In April,details of the considerably softened plan began to emerge. 49 As proposed by the TreasuryDepartment and eventually approved by Congress as part of the Omnibus BudgetReconciliation Act of 1993, Section 162(m) of the tax code applies only to public firms andnot to privately held firms, and applies only to compensation paid to the CEO and the fourhighest-paid executive officers as disclosed in annual proxy statements (compensation for allothers in the firm is fully deductible, even if in excess of the million-dollar limit). More46 Chronicle Staff and Wire Reports, “Big Earners cashing in now: fearful of Clinton’s tax plans, they rush toexercise their options,” San Francisco Chronicle (December 29, 1992).47 Siconolfi, “Wall Street is upset by Clinton’s support on ending tax break for ‘excessive’ pay,” Wall StreetJournal (October 21, 1992).48 Freudenheim, “Experts see tax curbs on executives’ pay as more political than fiscal,” New York Times(February 12, 1993).49 Greenhouse, “Deduction proposal is softened,” New York Times (April 9, 1993).-34-
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