The State of Regulation of Executive Compensation—How Did We Get Here?

The issue of executive compensation, and in particular how much executives are paid, is not a new issue. There have been various attempts throughout the years to regulate the amounts of executive compensation paid to CEOs and other executives. These attempts were largely reactive to down economic periods that resulted with many rank and file individuals losing their jobs whether as a result of mass layoffs or companies becoming insolvent, all the while executives of such companies seemed to continue to receive high salaries and even performance bonuses. Out of the 2008-2009 economic downturn came the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which included many provisions specifically to regulate executive compensation. While most of the mandates of Dodd-Frank relate to regulation through disclosure of pay, the attempt to regulate pay itself has come to fruition this summer. In July, the Securities and Exchange Commission (SEC) and five banking regulators released a comprehensive set of proposed rules (incentive-based compensation arrangements) that not only impose specific pay parameters on incentive-based compensation paid, but also limit pay that financial institutions may provide their executives. It is curious to see how we got to a place where executive pay can be regulated so.

Prior to the release of the proposed rules, executive compensation has been regulated in different ways through the tax code. For example, in the early 1980s, Congress added to the tax code Sections 280(G) and 4999 to regulate “golden parachute” compensation payments. Section 280(G) prohibits company deductions of golden-parachute payments where such payments exceeded three times an executive’s base compensation amount. Section 4999 imposes a 20 percent excise tax on the executives who receive these golden-parachute payments. In the 1990s Section 162(m) was added to the tax code to limit executive compensation deductions by a public company to only $1 million, not including “performance-based” compensation. As a result of Section 162(m), many public companies began to compensate their executives with “performance-based” compensation through applicable equity awards (e.g., stock options and stock awards, etc.) and other bonus arrangements where such compensation is dependent on satisfying certain financial metrics. While Section 162(m) was intended to reduce the amounts of compensation paid to certain executives, it arguably led to an increase in executive compensation paid and, some would argue, an increase in payment structures that incentivize executives to engage in riskier activities that could be harmful to a company’s long-term financial health.