Curing Excessive Executive Compensation -- and Reducing Job Off-Shoring -- Without Regulation

It is not really so difficult.

Because investors are a diverse group, they rarely get together on their own to force corporations to take specific actions. Thus, the power of investors to enforce change is ignored.

But, investors have another power that does not require concerted action--they vote with their feet, and, if the appropriate "force-fields" are erected, the sum of their individual actions will, in a way that would have pleased Tolstoy, change corporate behaviors.

First, the Congress and administration needs to establish some definition of "excessive." Let us say that it is total compensation in excess of 30-fold (or 25-fold, or 65-fold, or some other number) the average worker in that firm, or some higher multiple of the lowest quintile, or some other number. Something. This would be the major argument, but something can be agreed. It will be some number.

Once that definition is established, the only remaining step is to disallow capital gains treatment for investors in companies that do not meet that standard.

Investors will vote with their feet. They will tend to put their capital into companies whose compensation practices will allow investors to get the capital gains preferences. They will tend to take their money out of companies that pay excessive compensation according to the defined standard. Share prices of the non-conforming companies will go down and their cost of capital will go up.

On the other hand, if a company has a truly spectacular CEO, whose benefits to the company more than outweigh the tax rate differential, such as Steve Jobs, investors may invest anyhow. It would be a good measure of just how valuable a person really is.

Moreover, since investors do come together once annually to elect the Board, it is highly likely that they will sack a Board that paid excessive compensation and thus denied them capital gains treatment for their gains.

No regulation or regulators are needed. The company will have to state in the Annual Report, audited by outside accountants, that the compensation does, or does not, meet the standards. It would be part of normal reporting. Misreporting is actionable as fraud..

Note, under this proposal, the government is not telling companies what to do, but rather erecting a force-field and allowing them the choice. Force-fields permeate our tax code and government policy, and are often much more effective than regulations. Deductibility of interest rates on mortgages created (long before the bubble!) a nation with a high home-ownership rate. Title to land for working it helped settle the West in the 19th Century (Homestead Act).

Finally, if the definition of "excessive" is tied to some multiple the average worker or lowest paid quintile, the impetus for off-shoring is reduced because the major reason for doing so, to take advantage of lower wage workers, compromises the total compensation that the top people can get and still allow their investors to enjoy capital gains tax rate.

Not a bad dilemma for corporations to have to handle.

It is a "creative tension." Creative tension is good.

Comments

[gentlewomanfarmer]

Publicly held companies would have to report; privately held companies would not.

[joebaggadonuts]

Seems like a very reasonable solution to me. Except for very small companies. For example. If you have a superstar, say Madonna, who incorporates and has a secretary, her total compensation from that company cannot be in any year more than x times what her secretary makes. So if in a given year she pulls in 60 million dollars from residuals and movie rights and sales of music and tchotckies and concerts, the has to give her secretary a million dollars or two. Now, only she and her family are likely shareholders so it probably does not matter whether they get favorable tax treatment for sales o shares in this corporation, so perhaps even in this situation it's a good idea.

Thanks.

[texastrixie]

This was confusing. I think when it comes to taxes on investors, we will be much more like to rail against new taxes on our profits than new rules that would force American companies to BE American companies.

[texastrixie]

Don't hold your breath waiting for investors to force Boards of Directors to do anything. I have a little stock in a bunch of companies. I have no way to connect with all the other miniscule investors, and the idea we could ban together to do anything seems farfetched.

Also, investors are not simply going to sell their shares in companies that won't act according to govt mandates, most of us will simply call our Congress people and tell them not to vote for such a rule.

I agree we need to stop outsourcing, excessive executive pay, etc. But that is what we have a govt for! Why can't the Congress simply rule if a company sells mainly in America, any product must have 75% American made components or the item automatically gets a 100% duty. And rule that total executive compensation (salary, bonus, free car, etc.) above 100 times the lowest employee's fulltime wages will be taxed at 50%.

Trying to get everyone with 25 shares of say Exxon stock together to fix these problems is gonig to be much harder than all of us threatening our representatives and Senators with losing their next election (if we stick to this promise).

[Vurz]

good idea, except that the corporations would find a way to keep the low-paid offshore workers.

[Paul Abrams - Huffpost Blogger]

If they do, according to this proposal, "excessive" will be defined as some multiple, whatever it is, of that low-paid worker, or even the average, which the offshore low-paid will bring down.

However, the main point is that the govt can use investor motivation as a means of shaping executive compensation without ever regulating or taxing it.

[gentlewomanfarmer]

Exactly. Investors can use the various forms of social networking to band together. I'm no Warren Buffet, but I hold shares of publicly-traded stock and would be interested in finding like-minded investors in the same companies. The Obama model works, as we know.