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The Next Big Thing
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Posted by: Jack Ciesielski 12/22/2005 8:15 AM
Big honking front-page article on "tax gross-ups" in this morning's Wall Street Journal, by Mark Maremont. "Tax gross-ups" refers to the compensation practice of giving more dough to executives to make them whole after giving them a taxable raise or bonus. It's a great benefit to the employee, because it's the gift that keeps giving: the gross-up itself is taxable compensation, leading to more make-whole gross-up compensation and so on until the incremental gross-ups approach or reach zero.

I recommend it heartily; maybe even clip it and save it, because it might be one of those touchstone articles that you'll want to refer to in the coming months.

One thing in Maremont's story I found amusing: the gross-up practice took off in the 1980's as a reaction to the 20% special tax placed on "golden parachute" payments. If I'm not mistaken, it was then-celebrity CEO William Agee whose bungled attempt at taking over Martin Marietta earned him a ticket out of the executive suite at Bendix Corporation. His pay was considered outrageous at the time, and was part of the popular outcry that led Congress to pass tax legislation triggering the special tax anytime a fond farewell exceeded 3 times the regular compensation - which is why these things are always structured at 2.99 times compensation. Anyway, the point: this was a source of general indignation 25 years ago. The more things change, the more they stay the same.

I suspect that executive compensation and disclosure about executive compensation will be one of the noisier issues of 2006, for a couple of reasons. (Editorial note: "suspecting" is not the same as "predicting.") First of all, it's an evergreen issue. There's been emotional outrage over executive comp since capitalism began. It's an issue of fairness, which is a very subjective thing: one man's fair pay is another man's rip-off.
(Remember the J.P. Morgan maxim that he wouldn't lend to a firm where the top executive made more than 20 times what the average worker was paid? That was quite a while ago.)

And second, the disclosure is done so badly, it just looks like something illicit is going on in pay packages. That might change soon: the SEC is working on revamping executive disclosure rules for the first time in 13 years. Read these excerpts from Chairman Christopher Cox's speech at the Economic Club last week:

What we will propose is disclosure that permits a complete and accurate understanding of the compensation package. Any judgment or action taken on that information is up to boards of directors and investors, not us.

It is absurd to think that the owners of an enterprise should be denied full knowledge of how much they're paying their employees. The shareholders own the company, and the executives work for them. Think about it this way: Which of our nation's corporations issues signed, blank payroll checks for its employees to fill in the amount, learning only after the employee has cashed it just how much that check was for?

Not only will improved disclosure of company information be useful to shareholders, it will also help directors — by getting them better market information about executive compensation decisions in other companies. It will help make their judgments better informed, and less susceptible to challenge in expensive lawsuits that cost shareholders and companies alike.

... A proxy statement today may well contain all the required information, and yet still not tell anybody much of anything. Is it really disclosure if the investor has to sort it out and piece it together? Imagine the reaction from the press if I met their request for a transcript of every word in this speech by plunking down a dictionary. "There ya go. It's all in here somewhere." Technically, I'd have complied. In fact, I'd have provided nothing at all of value.

... If someone orders a steak, you don't give them a cow and a meat cleaver. Investors should get all the information they need — and they should get it in a form they can use.

He's got the right idea. But any change will likely be met with resistance. That's not so bad - but what will be toxic is the innovation that follows. Any rigid format for disclosures is bound to bring to life a slippery new compensation innovation that slides through the cracks of new SEC regulations. Let's hope that the Commission crafts something that will capture information about all the goodies.

* * * * * * * * * * * * *

Maybe it's because it's the end of the year and tax time is approaching, but it's been a good week for compensation articles. I forgot to mention Gretchen Morgenson's man-bites-dog piece in the Sunday New York Times: "The Boss Actually Said This: Pay Me Less." I don't think you'll see too many similar stories for a while.
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