Executive Compensation

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COMMENT

EXECUTIVE COMPENSATION DURING ECONOMIC TURMOIL

Student[1]

I. INTRODUCTION

The economic downturn in late 2008 brought forth the resurgence of an interesting topic - executive compensation. This topic was bound to bring much controversy as a result of the dramatic increase in executive compensation over the last decade[2] and the recent massive failure of many large companies.[3]

Adding to the public interest was the 2008 United States Presidential Election, which featured two candidates taking very strong stances on executive compensation.[4] As a result of the recent economic downturn, the government stepped in to try to prevent the economy from an even greater downturn, and as a result, restricted the compensation allowed for high-ranking executives of companies receiving bailout funds.[5]

The banking and investment crisis in 2008, the transition of Presidents, and legislation including the Emergency Economic Stabilization Act of 2008 (“Bailout”) and the American Recovery and Reinvestment Act of 2009 (“Stimulus package”), provide us with a great platform for a discussion on the topic of executive compensation. The goal of this article is to give a thorough overview of executive compensation as it exists in our society today. This article will examine executive compensation as it was,[6] as it is,[7] and what it might be in the future.[8] Also included in this article will be an examination of who sets executive compensation[9] and how it should be set.[10]

II. BACKGROUND ON EXECUTIVE COMPENSATION

A. Pre-1993 Law

Prior to 1993, “there was no specific limit on the amount of deductible compensation.”[11] Companies were able to use compensation paid to employees for tax deductions to help save money by paying fewer taxes. Also included in this tax deduction was the salary of the top executives, even the chief executives at very large corporations.[12] There was governmental concern about the amount of excessive compensation paid to executives at the time, which lead the government to make efforts to reduce the amount of compensation executives could receive.[13]

B. 1993 Changes

A tax change in 1993 put a $1 million limit on the deductibility for top ranking executives’ salaries at public companies.[14] These “top ranking executives” included the CEO and the four highest compensated officers not including the CEO.[15] As a result of this change, if an executive makes more than $1 million in a given year in cash or benefits other than cash, then the company cannot deduct the executive’s salary for any amount beyond the $1 million threshold.[16] In order to pay executives more than the $1 million per year cap and still benefit from a tax deduction, companies used other types of compensation that do not count towards the $1 million cap, allowing them to pay executives basically as much as they wanted, but still receive a tax break.[17]

C. Types of Executive Compensation

There are many different types of executive compensation.[18] With the 1993 tax law changes, companies have been forced to find alternatives to salary (cash) in order to continue paying their high-level executives more than $1 million and still benefit from a tax deduction from the compensation paid to their high-ranking executives.[19] The alternatives that companies have found normally have to do with performance-based compensation because this type of compensation has been deemed to be tax-deductible, even beyond the $1 million threshold set in 1993.[20]

i. Salary

The most common and recognized type of executive compensation is the executive’s salary (cash).[21] Quite simply put, an executive’s salary is the base amount of cash paid to an executive, and is normally paid on an annual basis.[22] Salary is not based on performance, but is essentially the lowest possible amount that can be paid to an employee...
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