Amanda DeMatteis: Hi, Josh.
Josh Goodbaum: Hi, Amanda. What are we talking about today?
DeMatteis: I thought we would talk about executive compensation. There have been a number of questions, even in the news recently, about whether or not executives of companies have any restrictions on how much money they can earn in comparison to subordinates or lower-level employees that work for the company they manage. What can you tell us about that?
Goodbaum: Yeah, we see a lot of this, Amanda, where there’s a discussion about the ratio between the compensation of the CEO and the compensation of the average workers that that CEO manages. What used to be, decades ago, a ratio of 10 or 20 or maybe 30 to 1 is now a ratio of hundreds or thousands to 1. Executive compensation, a lot of people think, is really out of control.
But you might be surprised to learn that the law has almost nothing to say about this. There are a few areas in which the law regulates executive compensation, but there is no overarching law that says, “Executives are not allowed to earn more than X amount of money,” or, “Executives are not allowed to earn more than 10 times what their average employee earns.”
Let me review the restrictions that do exist.
One is nonprofits. Non-profit organizations – 501c3s and other kinds of tax-advantaged organizations – have certain rules about how their executives can be compensated. Their executives cannot make more than a certain amount of money. Their executives have to be doing certain kinds of functions. This is an area of the law called the tax-exempt organizations practice, and there will be really complicated rules there; though, in fairness, we don’t usually see the executives at non-profits being the highest earning executives in the country. Mostly, those are in for-profit companies.
There’s another restriction about the tax deductibility of executive compensation. Above a certain level, it’s possible that the company cannot consider the cost of that executive compensation to be a cost on their balance sheet, and therefore, they would essentially have phantom profits based on having executive comp that’s too high. That’s one of the reasons that you see a lot of executive comp done in the form of options or stock rather than straight-up cash compensation. So, that tax deductibility issue comes up in the context of executive compensation.
Another issue – and this isn’t really a restriction on how much executives can earn – is just the question of disclosure. For every publicly-traded company, they have to file disclosures with the Securities and Exchange Commission (SEC). They probably have to file disclosures with their state government as well. Those disclosures are almost certainly gonna talk about executive compensation as a piece of information that shareholders and potential shareholders want to have access to.
Finally, Amanda, there is a way in which the government sometimes regulates executive compensation more directly. So, in connection with certain federal government spending programs, the government has said in the past, ”We are only going to provide this money to companies or we’re only going to loan this money to companies that have a certain kind of ratio of executive to employee compensation.” I’m thinking in particular of the TARP program during the Great Recession. This is the Troubled Asset Relief Program, where I believe Congress did write into the law, “We’re going to give this money to companies to bail them out, but we’re not gonna give it to the companies unless their CEO to employee compensation ratio is below a certain range.”
In theory, that’s something that Congress could do more of. We haven’t seen a lot of appetite for that, and I don’t expect we will, but that’s maybe the most directly that Congress and the federal government has tried to regulate the way that for-profit companies pay their executives.
DeMatteis: This is really useful to know, especially if you’re an executive that is negotiating an employment agreement and thinking about creative ways to get compensation outside of just straight salary or bonus.
Thank you so much, Josh, for this, and thank you for watching. Take care.