Back in 2014, I reviewed Michael Dorff’s estimable book Indispensable and Other Myths. In it, I noted that:
Dorff rightly concludes from a lengthy analysis of both empirical evidence and laboratory studies of decision making, “performance pay very likely … does not result in better performance.”
As I likewise observed in a Texas Law Review article reviewing Bebchuk & Fried’s book, there is relatively little evidence that CEOs are motivated by pay, which suggests the possibility that CEOs are motivated principally by other concerns such as ego, reputation, and social effort norms. Put another way, the latter considerations may be the principal mechanisms by which the principal-agent problem is resolved. If so, evidence advanced by either side to show that incentive compensation either does or does not improve performance tells us nothing other than that researchers have mined the data to find a spurious correlation. Worse yet, at least from the perspective of those who wish to use compensation to address the principal-agent problem, the goal of linking pay and performance inevitably will prove an exercise in futility. ...
As Dorff points out, although CEO pay had been growing fast relative to other metrics during the 1980s, it was in the 1990s that CEO pay really started to explode as a percentage of corporate profits and total wages. In large measure, this occurred because of a huge shift towards options and other forms of incentive pay that were tax favored under the 1993 amendments.
Despite this temporal correlation, Dorff downplays the role that regulation in general and § 162(m) play in our story.
In contrast, I think it was a pivotal moment. As former SEC Chairman Christopher Cox noted, it deserves a “place in the museum of unintended consequences.”
It’s not just that § 162(m) created tax incentives for using performance pay schemes. I believe § 162(m) is a prime example of how law, by expressing social values, can change social norms or even create new norms. ...
CEO pay thus is an artifact of neither managerial power nor arms-length bargaining. Instead, its current structure and size is a product of a paradigm shift that has become deeply embedded in the social norms that regulate boardroom decision making. Which explains why boards refused to “reverse course.”
Regulation played a critical—albeit unintended—role in this process by validating the emergent norm and giving it a seal of approval not just from leading theorists but also the Congress and President of the United States. ...
In any case, as The Economist explained:
Mr Dorff believes that performance-related pay should be scrapped and managers paid a salary. This would be good for shareholders: the pay revolution has dramatically increased the proportion of profits that go to the CEOs. It would be good for the country because it would reduce the likelihood of future Enrons or Lehman Brothers. It would even be good for CEOs who would have a guaranteed income.
Which brings me to the GOP tax plan. Bloomberg reports that:
Under current law, businesses can write off as much as $1 million in compensation expenses for chief executive officers and four other top-paid bosses, plus any amount beyond that if it's tied to performance targets. The Republican proposal unveiled Nov. 2 would keep the $1 million threshold but eliminate the exemption for pay linked to results, denying companies the option to write off large equity awards.
This is not my preferred solution. As I argued back in 2014:
I think the solution is a massive deregulation of CEO pay. Eliminate all tax rules that penalize some pay formats and all rules that subsidize others. Eliminate say on pay, the Section 16(b) exemptions for incentive pay, and so on. Leave in place only simple, clear disclosure rules (with no nonsense about CEO-worker pay ratios or what have you), and let sunlight be your disinfectant and electric light your policeman.
