THURSDAY, FEBRUARY 4, 2009

Kathleen Pender

Thursday, February 5, 2009

Not if history is any guide.

Since at least 1984, Congress and accounting authorities have enacted measures designed in whole or part to stem runaway pay. Yet compensation for top executives has continued to climb in both dollar terms and as a multiple of average worker pay.

No matter what Congress cooks up, it seems like executives, companies and their consultants find a way over, under or through the rules.

"It's like putting up a dam for a river. The water tries very hard to find a way around it," says John Olson, a partner with Gibson Dunn & Crutcher who advises corporate boards on compensation and other matters.

Some examples:

-- In 1984, Congress imposed tax penalties on excessive payments, called golden parachutes, given to executives who lose their job following a change in control of the company. Under the law, if a parachute exceeds 2.99 times the executive's annual pay, the company cannot deduct the excess amount and the executive could owe a 20 percent excise tax on it.

But instead of shrinking, the average golden parachute swelled as companies that had been making more modest payments came to see 2.99 times pay as a standard. Olson says the average parachute grew from less than 2 times pay before the law took effect to 2.75 times after.

What's more, some companies continued paying parachutes bigger than 2.99 times pay. In addition to giving up their own tax deduction, some even agreed to pay the executive's excise taxes. They also paid the income tax the executive owed on the excise tax payment, as well as the tax on the tax and so on.

These payments, known as a tax gross-up, grossly inflate the cost of the excise tax to the company, says Alexander Cwirko-Godycki, research manager with Equilar, a compensation-data company.

Many executives also receive tax gross-up payments on taxable perks such as personal use of the corporate jet, although public scrutiny is making this less common.

-- In 1993, then-President Bill Clinton, who had promised during his campaign to rein in executive pay, signed a law that prohibited companies from taking a tax deduction for top-executive compensation that exceeded $1 million per year. But there was a loophole: Any pay over $1 million could still be deducted if it was somehow performance-related.

"That's what led to the huge growth of incentive plans, including stock options," Olson says.

The result: In 1992, the average chief executive earned $5 million, or 126 times the average hourly worker. By 2007, the average CEO was earning $12.3 million, or 275 times the average worker, according to Lawrence Mishel, president of the Economic Policy Institute.

-- In 2006, after a 10-year battle, the Financial Accounting Standards Board required companies to start deducting an expense for stock option grants on their income statements. "It was thought this would rein in the excessive use of options," says Corey Rosen, executive director of the National Center for Employee Ownership.

Instead, it merely shifted some compensation from stock options to other forms of equity that companies had long had to expense, such as restricted stock. It did nothing to tame the growth of executive compensation. "If anything, it ratcheted it up even further," Rosen says.

Why can't our legislators seem to pass a measure that has teeth?

"Because Congress is not as smart as the people who are immersed in this," says Jesse Brill, chair of CompensationStandards.com. "People will always be able to find a loophole."

Although Obama's plan will apply only to companies taking bailout money in the future and has escape hatches of its own, he has promised that more sweeping reforms will be coming.

In the Senate, Obama was a champion of Say on Pay, which would require public companies to give shareholders a nonbinding vote on executive compensation. The company could ignore the vote, although doing so would stir controversy.

"You can try all these different reforms," Rosen says, but none will be truly effective "unless the board of directors, the media and public stop thinking of executives as superstars and that if we just get the right CEO, everything will be OK. If anything, the events of the last year have shown that a company's success is a lot more complicated. And a lot of it is nearly random."

Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.

This article appeared on page C - 1 of the San Francisco Chronicle

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