Wednesday, September 06, 2006

Executive Governance: Congressional Hearings and more

I worked at home this morning in order to watch the Senate Finance Committee's meeting on Executive Compensation. It was interesting but did not cut much new ground.

Predictably, the session began with the numbers (for instance that CEOs made more than 300 times the average employee in 2004), the problems of backdating options (including the need to redo tax records), and the principle-agent conflicts that arise when executives are paid large amounts of money.

Why are taxes so important of issue here? One reason is that firms can deduct over $1 million per executive only if that pay is incentive based. Back-dating the options loses that incentive component and thus disallows the deduction.

Consider the following from Business Week:
"Known as Section 162(m) of the Internal Revenue Code, that provision limits the tax deductibility of pay for the five highest-paid executives at public companies to $1 million, unless the pay is determined to be "performance-based." To qualify as performance-based pay, compensation committees must set "pre-established" and "objective" performance goals. Shareholders must approve the goals, and the compensation committee must certify they were met.....

But corporate governance experts, academics, and some members of Congress contend that many big companies have figured out how to bypass the rule by setting easy-to-reach goals that make the lion's share of executive pay —from bonuses to stock grants "performance-based" so they can write those payments off on tax returns.

BILLIONS IN LOST TAXES. The net effect, say critics, is that many companies now deduct almost all of their top executives' compensation"

C-Span also covered the Finance Committe's panel question and answer period. Some highlights from the panel discussion.
  • Charles Elson of Univ Of Delaware was possibly the best speaker. He commented on why congress should care--short version: if shareholder confidence is lost, they quit investing.
  • Steven Balsam a Temple Accounting Professor was also excellent. He called for more disclosure and consistent tax treatment.
  • Lucian Bebchuk of Harvard Law emphasized the size of the compensation and that there were conflicts and rules. Moreover, how deferred compensation was taxed advantaged to the executive but not the firm.
  • Nell Minow of the Corporate Library seemed more rehersed. She continually painted the gloomiest picture that governance was not working and more oversight was needed. She even commented on how airfare was taxed. That said, it is sad that she was generally right.
Senatore Grassely who led the meeting concluded by saying he will be asking for board minutes of firms that did backdate options.

Interesting discussion. I wish I had recorded it. Hopefully it will be online soon.

This meeting came on the heels of a NY Times report that backdating was a more serious problem than previously thought:
"A new study estimates that the stock options backdating scandal may cost shareholders hundreds of millions of dollars. The study was released on the eve of two Senate committee hearings that plan to examine the scope of the widening investigation into improper options practices.

Three researchers at the University of Michigan estimated that backdating stock options between 2000 and 2004 helped sweeten the average executive'’s pay by more than 1.25 percent, or about $600,000. But the fallout from the recent options investigations has caused those executives'’ companies to fall in market value by an average of 8 percent, or $500 million each.

“For about $600,000 a year to the executives, shareholders are being put at risk to the tune of $500 million,” the study concludes."

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