The Executive Compensation Controversy - Fondazione Rodolfo ...

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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISexecutives in recently privatized utilities. Both controversies led to calls for increasedcompensation disclosure, especially with respect to stock option plans.In the USA, the controversy culminated with the passage of IRS Section 162(m), thatimposed a $1 million cap on the deductibility of executive compensation, unless thatcompensation was performance-based. Though the explicit intent of Section 162(m) was toreduce levels of pay, it had the opposite effect by fueling the explosion in stock option grantsthroughout corporate USA. In contrast, the UK the controversy culminated with thewidespread adoption of the Greenbury recommendations, which demanded that options haveperformance-vesting provisions and encouraged the use of performance shares over options.In a sense, the USA has recently moved closer to the UK with the increasinglyimportance of restricted stock over traditional stock options: perhaps Figure 2.10 (showingtime trends in restricted stock vs. options in the USA) will soon converge to Figure 3.3).However, in contrast to the performance vesting of shares and options in the UK, the vestingand exercisability of almost all USA stock and options is triggered solely by the passage oftime and not by meeting performance criteria.3.4.2. FranceThe concept of stock options was introduced in France as long ago as 1967, despitePresident Charles de Gaulle’s suspicions of anything emanating from the USA. 101 Franceformally made executive stock options legal in 1970 but, due in part to the stagnant stockmarket of the 1970s and the high marginal tax rate on option exercises, the first executiveoption plan was not created until 1984. 102 In that year, the (interestingly) socialist Frenchgovernment passed a rule taxing options as capital gains (at a top rate of 19.4%) rather thanas ordinary income (at a top rate of 60%), greatly increasing their attractiveness. 103 As aresult of these new incentives, the use of stock options in France quickly approached theiruse in the UK (see Table 3.10).101 Graham, “The soft option - The compromise reached over the taxing of executive share,” Financial Times(April 28, 2000b), p. 18.102 Delaney and Wessel, “Lumpy Gravy: Suppose Stock Options Involved More Pain Than Financial Gain ---That's the Case in Europe, Which Helps to Explain High-Tech Lag There --- `A Bit Perverted' in France,” WallStreet Journal (December 21, 1999a), p. A1.103 Ricklefs, “Changing Course: French Voters Prod Socialist Leadership To Veer Right Sharply ---Government Reduces Taxes, Advocates Stock Options; Impetus: Unemployment --- Virtues of PrivateEnterprise,” Wall Street Journal (September 26, 1984).-89-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISStock options for French CEOs came under attack in the early 1990s, as executivesbegan exercising options granted under the tax rules passed in 1984. 104 In May 1995, aSenate Commission proposed sweeping new disclosure rules for stock options that wouldrequire firms (for the first time) to report detailed information on option grants, and wouldalso prohibit grants made prior to favorable information disclosures. 1053.4.3. GermanyMore to come.3.4.4. ItalyStock option plans in Italy existed before 1990, but were mainly limited to subsidiariesof multinational companies (Marchettini (2001)). Prior to 1998, executives exercising optionswere subject to employment income tax and both the executive and employer were subject tosocial insurance tax. Under new tax policies effective in July 1998, stock options plans usingnewly issued shares were no longer considered taxable income (and were taxed at a lowered12.5% capital gains rate). At about the same time, corporate-governance rules approved bythe Italian government made it easier for companies to launch capital increases needed forstock-option programs. 106 As a result of these two changes, the use of options escalated, andby the end of 1998, half of all companies on the Milan Stock Exchange were either using orplanning to introduce stock-option plans (Brunello, Graziano and Parigi (2001)).In January 2000, the Italian government new policies to both curb perceived abusesunder the current system (in which some executives had received highly discounted options)and to further encourage stock option grants, especially those to lower-level employees. 107First, the new rules provided an exemption from income tax and social insurance on thespread at exercise up to a threshold of €2,065 per employee per year, as long as the optionswere offered to all employees, and the shares were not sold for three years after exercise.Second, the new rules provided for capital gain treatment for all options (and not only those104 Jack, “France to Reform Stock Options,” Financial Times (December 22, 1994), p. 2.105 Jack, “Paris Urges Share Option Reform,” Financial Times (May 17, 1995), p. 2.106 O'Brian, “Italian Companies Begin to Provide Stock Options, Details of Financial Data,” Wall StreetJournal (May 29, 1998); “Italy's Compart To Offer Execs Stock Options; Joins Trend,” Dow JonesInternational News (March 16, 1998).107 Salvatore, “Taxation Of Stock Options - A Summary Of Latest Developments - Graham & James,”Mondaq Business Briefing (March 1, 2000); Werdel and Diamond, “Navigating stock options in Europe,”Workspan (August 1, 2002), p. 28.-90-
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