Upper Saddle River, N.J. – September 12, 2006 – The governmentâ??s
investigation into the excesses of executive compensation has now
expanded into the practice of granting backdated stock options,
with at least 100 companies now under the microscope. This seemingly
widespread and highly questionable practice has triggered the
governmentâ??s consideration of ways in which to put a lid on what many
consider to be an abuse of executive compensation.
IRS Section 162m, in force since 1993, allows companies to deduct
compensation above $1 million, for certain executives, only when it is
performance-based. The rules interpreted stock options as being
performance-based, whereas restricted stock grants are not, if the
restriction is tied to time vesting. Because of the variable accounting
treatment for performance-based stock options and restricted stock,
most companies have not attached specific requirements to these grants.
According to a recent article in the Wall Street Journal , Congress is
open to considering the elimination of the performance exclusion.
Although they expect stiff opposition to this change from
publicly-traded companies, the recent introduction of Sarbanes-Oxley and
expensing of stock options under FASB regulations appear to indicate
that mass public and media outcry are more successful currently at
driving reform than any actions from the business community.
It is interesting to note that some individuals within the government
recognize that changes in the regulations can have huge and totally
unexpected consequences. The exponential increase in the use of stock
options that began in the second half of the 1990â??s was a clear result
from the enactment of Section 162m. The total elimination of the
performance exemption would have a tremendous impact on the financials
of many companies; any change in the regulations may therefore be
tempered by only eliminating the exemption currently tied to
nonperformance- based stock options.
What should a company do? Other than giving input to your
representatives in Washington, the most important thing to do is to take
a hard look at your current executive pay programs and determine if
they will pass the â??sniff testâ?. Are they performance-based, and
are the underlying performance criteria tied to increasing
owner/shareholder value? Is the amount paid out commensurate with the
competitive market, and is it appropriate, given the level of
performance achieved? Does the overall program address the four major
objectives of compensation: 1) focus attention on desired results; 2)
attract qualified talent; 3) retain valued and productive employees; and
4) motivate them to achieve improved results. If these questions can
be answered positively, there is a good chance that the programs reflect
a balance between executive needs and those of the company and its
stakeholders. If some of these questions are answered negatively, the
programs should be further examined and revised so that they will pass
increased scrutiny.
Paul R. Dorf is the Managing Director of Compensation Resources, Inc.
He is responsible for directing consulting services in all areas of
executive compensation, short and long-term incentives, sales
compensation, performance management systems, and pay-for-performance
salary administration. He has over 40 years of Human Resource and
Compensation experience and has held various executive positions with a
number of large corporate organizations. He also has over 20 years of
direct consulting experience as head of the Executive Compensation
Consulting Practices for major accounting and actuarial/benefit
consulting firms, including KPMG, Deloitte Touche Tohmatsu (formerly
Touche Ross), and Kwasha Lipton.