Curt Verschoor on Ethics

CHAPTER 4ETHICS OF EXECUTIVE COMPENSATION

Hypothetical Earnings Trigger Real Bonus Payments

The Revenue Reconciliation Act of 1993 caps the deductibility of executive salaries at $1 million, but bonus payments of any amount are deductible if they result from the achievement of established performance goals. Many public companies today take advantage of the performance-based bonus payment system, using misleading bonus calculations to give “superior performance” bonuses at the expense of shareowners and taxpayers.

The congressional Joint Committee on Taxation reports that these tax-advantaged bonuses cost the U.S. Treasury $3.5 billion per year. Dozens of corporations reward subpar returns to shareowners. According to the September 13, 2013, Bloomberg News article, “Companies Use IRS to Raise Bonuses With Earnings Goals,” the CEOs of 63 large companies in the Standard & Poor’s (S&P) 500 Index received cash bonuses in 2012 based on corporate performance even though their company’s shares underperformed that of the Index. Bloomberg quotes Robert Reich, the secretary of labor under President Bill Clinton, who said, “Taxpayers are losing billions of dollars; shareholders are being taken for a ride.”

Tax-deductible bonuses based on company performance were undoubtedly allowed because Congress believed it’s in the best interests of shareowners: Performance-based compensation includes stock option and appreciation rights awards. At least two outside independent directors must approve ...