Already, Netflix has responded by raising the salaries of three of its top executives and dumping a short-lived program that tied their pay to company performance. Corporate boards nationwide are considering whether to do the same, executive compensation experts say.
How companies, particularly on Wall Street, pay their top executives has been thorny issue for years. President Bill Clinton campaigned against excessive pay for chief executives and pushed a measure to cap at $1 million the amount that corporations could deduct from their tax bill for top executives’ compensation. But the law included a compromise: Companies could still deduct pay over $1 million if it was “performance-based.”
Instead of stopping the growth of executive pay, the law helped supercharge it, according to academics who have studied the issue. Companies that paid their chief executives less than $1 million a year often boosted their salary and many began looking for ways to take advantage of the loophole for deducting the cost of “performance-based” pay, they said. In 1989, according to the left-leaning Economic Policy Institute, the median value of annual CEO compensation was $2.7 million. By 1995 it was $6.6 million, and it reached $13 million in 2016.
“Market forces drive CEO pay. There is a market for CEOs, just like there is for football coaches and actors, and some of them are well paid,” said Jim Barrall, senior fellow in residence at the UCLA School of Law and former chairman of the executive compensation practice at Latham & Watkins.
“History proves that when the tax code has been used to limit executive compensation, it has not worked and has had unintended consequences,” he added.
Investor advocates complained for years that corporations were taking advantage of the tax policy. The deduction saved the top 20 banks $725 million on performance bonuses between 2010 and 2015, according to an Institute for Policy Studies report. In 2006, then-Securities and Exchange Commission chief Christopher Cox told a Senate committee that the law “deserves pride of place in the Museum of Unintended Consequences.”
The 2017 tax law does away with the deduction for performance-based pay, potentially steering $9.3 billion to federal coffers over the next 10 years, according to the Joint Committee on Taxation.
But compensation experts say the change in tax law is not likely to reverse years of upward pressure on executive pay. If anything, companies are likely to make such pay less dependent on performance-based bonuses and give executives a higher salary, they say.
“Some people will hope this reduces executive pay; I don’t think it will,” said Alan Johnson, managing director of pay consultant Johnson Associates.
Some companies are already adjusting their policies. Netflix began offering stock-based bonuses to three of its top executives in 2015, taking advantage of the tax deduction. Last week, the company said it would ditch the bonuses and increase the annual salary for the executives in 2018. For example, in 2017, Netflix’s Chief Content Officer Ted Sarandos earned an $1 million salary and bonus target of $9 million. For 2018, his base salary will be raised to $12 million, according to a Securities and Exchange Commission filing.
“The compensation committee of the board of directors has determined that all cash compensation for 2018 will be paid as salary,” the filing said.
Also, the new tax bill’s signature feature — lowering the corporate tax rate from 35 percent to 21 percent — more than offsets the loss of the deduction for corporations, compensation experts say.
“The tax bill included a CEO pay reform that we’ve been calling for about 20 years, but we’re not bragging about it because it will not make up for all the other corporate giveaways in the legislation,” said Sarah Anderson, global economy project director for the Institute for Policy Studies, a social justice think tank. “We would like to think this would result for an overall decline in compensation that it could inject some rationality.”
Still, the elimination of the tax deduction for top executives’ bonus pay may prompt some shareholder advocates to call for restraint, said Andersen of the Institute for Policy Studies. “These huge CEO pay packages will come at a higher price for the companies,” she said. “It will certainly give shareholders another argument to make for why this [big pay packages] is not in shareholders’ interest.”
After the new law passed, Goldman Sachs accelerated the delivery of some stock bonuses to top executives by a few weeks. Chief executive Lloyd Blankfein and “hundreds” of other bank executives received the shares — which they had already been awarded in prior years — in December rather than January.
Transferring the shares in 2017 allows the company to take a deduction while the statutory tax rate is 35 percent, rather than the lower rate put in place for 2018. The maneuver, which the company disclosed in SEC filings, aims to save the bank $140 million, according to a person familiar with the issue who spoke on the condition of anonymity.
Regulators and lawmakers have made other efforts to restrain executive pay — or at least throw a spotlight on to it. After years of wrangling, regulators put in place a rule last year requiring thousands of public U.S. companies to share how much more their chief executives earn than their typical rank-and-file employees. The “pay ratio” disclosure threatens to put a spotlight on a potentially embarrassing disparity that many companies have long fought to obscure.