Executive Pay: Clinton's Curbs Are Out Of Touch And Out Of Bounds

President Clinton thinks that executives make lots more than they deserve. So he wants to cap at $1 million the tax deduction companies can take for what they pay their bigwigs.

Clinton is a master at populist rhetoric. And he's playing off of what an aide calls the public's "sense of outrage" over rock-star-like compensation for some CEOs. But his proposal just gets the government tangled up in matters best left to shareholders.

Besides, Clinton's plan will do little to hold down the megabucks payouts that have grabbed the nation's attention. "Executive pay is market-driven," says Robert Cizik, chairman and CEO of Houston-based Cooper Industries Inc. "Tax action won't make a difference."

The main reason Clinton's plan won't work is that he would exempt compensation packages that are linked to performance or productivity. Since nearly all executive-pay is tied to performance, it won't be hard for companies to dodge the rules. That means that the Clinton plan will do little more than change the way a handful of high-priced execs are paid. In fact, fewer than 400 executives of public companies earn more than $1 million. And those mostly large businesses will barely notice the tax hike. "It's not on my radar screen," says Lawrence E. Fouraker, who sits on the compensation committee at Gillette Co.

PLAYING THE ANGLES. Those whose compensation schemes aren't already linked to performance will easily find a way around the rules. "Creative minds will come up with ways to reward executives [and] satisfy boards," says Andrew Klein, a compensation consultant at Wyatt Co. Incentive stock options and restricted stock could provide the loopholes.

Indeed, incentive-based options are a wonderful example of what happens when the government tries to meddle in the complex world of executive pay. Not only do they provide a way for companies to avoid the deductibility cap, they are also a means for corporate execs to duck Clinton's other proposed tax hikes. For instance, Clinton wants to raise the top income tax rate to 36% and impose a surtax on high-income individuals. But when stock obtained through an ISO is sold, profit is taxed as a capital gain--at 28%. And it won't be subject to the surtax.

Proposed new accounting rules may require employers to charge the value of the options against earnings, however. Says Peter Elinsky, a partner at KPMG Peat Marwick: "Companies are going to have to decide what's more important, earnings per share or employees demanding a tax benefit as part of compensation."

And that's the biggest problem of all. The Clinton plan's effect on pay may be largely symbolic, but it could encourage more corporate accounting gimmicks. Says Lilli Gordon, a consultant: "There are all sorts of ways to manipulate performance data. You can lay off employees. You can buy back stock. You can defer charges. It can create terrible distortions."

Curiously, Clinton's initiative comes after the Securities & Exchange Commission already has given more power over compensation to the people who really deserve it--the shareholders. And big institutions, which haven't been shy about throwing their weight around lately, will use their new clout to keep pay under control. The President may be trying to fix a problem that's already being solved.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE