The Social Insurance Crisis And The Problem Of Collective Saving: A Commentary On Shaviro\u27s Reckless Disregard

Long-range Social Security and Medicare spending projections vastly exceed projected program revenues. If left unchecked, the resulting fiscal imbalance (estimated at $40 to$70 trillion in present value terms) would fall primarily on future generations. To avoid generational inequity, and perhaps fiscal meltdown, Professor Daniel N. Shaviro and others propose immediate fiscal austerity. This reply Commentary argues that near-term austerity is unlikely to play a significant role in overcoming the fiscal imbalance, which can be thought of as a balloon payment due in the mid-twenty-first century. Significant near-term fiscal austerity would eliminate the public debt and replace it with a public surplus. Political economy theory and U.S. public debt history suggest that this path is infeasible. This Commentary also stresses the importance of clisaggregating the Social Security and Medicare problems. Contrary to popular belief, Medicare is by far the larger problem, and the Medicare imbalance is driven by projected spending increases, outpacing overall economic growth indefinitely. These observations suggest that a focus on Medicare cost control, rather than revenue enhancement, is called for

The Challenge of Improving the Long-Term Focus of Executive Pay

A consensus is developing that executive compensation in the United States is inadequately linked to long-term company performance, resulting in reckless, short-term decision making. Congress, the Obama administration, and academic commentators have recently embraced dramatic restrictions on the form and holding period of senior executive pay, at least for some companies. A common view is that although regulation of the amount of executive pay would do more harm than good, regulation of form and term is desirable. This Article questions that view. It highlights the challenges of fruitfully regulating the form and term of pay arising from the complexity and diversity of executive pay arrangements, uncertainty as to the underlying reasons and hence appropriate remedies for short-termism, and the conflict between deterring reckless short-term behavior and encouraging sufficient risk-taking to maximize share value over the long term. It analyzes and critiques existing regulatory proposals, and, although not endorsing a regulatory solution, offers two ideas that policy makers should consider if faced with crafting a regulatory response to short-termism: first, focusing regulation solely on the term of pay, leaving form to company discretion, and second, adopting a comprehensive disclosure-based response

Financial Accounting and Corporate Behavior

The power of financial accounting to shape corporate behavior is underappreciated. Positive accounting theory teaches that even cosmetic changes in reported earnings can affect share value, not because market participants are unable to see through such changes to the underlying fundamentals, but because of implicit or explicit contracts that are based on reported earnings and transaction costs. However, agency theory suggests that accounting choices and corporate responses to accounting standard changes will not necessarily be those that maximize share value. For a number of reasons, including the fact that executive compensation often is tied to reported earnings, managerial preferences for high earnings generally will exceed shareholder preferences, leading to share value reducing tradeoffs between reported earnings and net cash flows. The empirical literature on the details of positive accounting theory is mixed, but the evidence firmly establishes the power of accounting to shape corporate behavior. The power of accounting and the divergence of interests have many implications for courts and policy makers. For example, consideration of proposals to increase conformity between tax and financial accounting rules as a means of combating tax sheltering and/or artificial earnings inflation must take into account the incentive properties of accounting standards and recognize that narrowing the gap between tax and book income will have economic consequences, however the gap is narrowed. This Article considers this and other implications of the behavioral effects of accounting standards, including the possibility of setting accounting standards instrumentally as a means of regulating corporate behavior, an alternative to tax incentives, mandates, or direct subsidies

The Practice and Tax Consequences of Nonqualified Deferred Compensation

Although nonqualified deferred compensation plans lack explicit tax preferences afforded to qualified plans, it is well understood that nonqualified deferred compensation results in a joint tax advantage when employers earn a higher after-tax return on deferred sums than employees could achieve on their own. But the joint tax advantage depends critically on how plans are operated; chiefly how plan sponsors use or invest deferred compensation dollars. This is the first Article to systematically investigate nonqualified deferred compensation practices. It shows that joint tax minimization historically has taken a backseat to accounting priorities and participant diversification concerns. In recent years, the largest source of joint tax advantage likely stems from use of corporate owned life insurance (COLI) to informally fund nonqualified deferred compensation liabilities. To be sure, the reduction in corporate tax rates enacted in the Tax Cuts and Jobs Act increases the joint tax benefit of nonqualified deferred compensation. Nonetheless, this Article recommends a measured response focusing first on COLI reform and an extension of the application of the Affordable Care Act’s Net Investment Income Tax to nonqualified deferred compensation earnings, before considering fundamental reform of the taxation of nonqualified deferred compensation. This Article also reveals that nonqualified deferred compensation results in an undisclosed advantage to corporate executives, as it provides what are effectively above-market returns on retirement savings, and that, at least in recent years, shareholders, not taxpayers, have provided the bulk of the subsidy for nonqualified deferred compensation

The Manager\u27s Share

It is sometimes argued in the corporate governance literature that the total share of corporate value that can be extracted by a manager is fixed and independent of the avenues through which value is extracted. Shareholders need not worry about an activity such as insider trading, the story goes, because any profits achieved by a manager through insider trading will simply offset conventional compensation. This Article challenges that idea and argues that whether one views the manager\u27s share as being capped by external market forces, set by an optimal principal/agent contract, or limited by saliency and outrage in accordance with the managerial power view of corporate governance, the total value that can and will be appropriated by managers will be a function of the number and type of avenues through which value can be appropriated. Although analysis of each of the corporate governance mechanisms results in the same directional prediction, the magnitude of the impact of expanding channels of appropriation depends on which mechanism dominates. For example, potential avenues of appropriation that are easily monitored and under the unilateral control of the directors, such as bonuses or perks, should have little effect on incremental appropriation under the optimal contracting model, but could have significant impact under the managerial power model. A review of the relevant empirical literature suggests that additional avenues of appropriation do indeed lead to greater overall appropriation. The evidence, moreover, is largely inconsistent with the optimal contracting view. This analysis highlights a largely overlooked cost of compensation complexity: In all likelihood, the increasing complexity and opacity of executive compensation over the last two decades has contributed to the overall increase in managerial appropriation

Financial Accounting and Corporate Behavior

The power of financial accounting to shape corporate behavior is underappreciated. Advocates of positive accounting theory have argued that even cosmetic changes in reported earnings can affect share value, not because market participants are unable to see through such changes to the underlying fundamentals, but because of implicit or explicit contracts that are based on reported earnings and transaction costs. However, agency theory suggests that accounting choices and corporate responses to accounting standard changes will not necessarily be those that maximize share value. For a number of reasons, including the fact that executive compensation is often tied to reported earnings, managerial preferences for high earnings generally will exceed shareholder preferences, leading to share value reducing tradeoffs between reported earnings and net cash flows. Empirical evidence supporting the detailed predictions of these theories is mixed, but the evidence firmly establishes the power of accounting to shape corporate behavior. The power of accounting and the divergence of interests have many implications for courts and policy makers. For example, consideration of proposals to increase conformity between tax an d financial accounting rules as a means of combating tax sheltering and/or artificial earnings inflation must take into account the incentive properties of accounting standards and recognize that narrowing the gap between tax and book income will have economic consequences however the gap is narrowed This Article considers this and other implications of the behavioral effects of accounting standards, including the possibility of setting accounting standards instrumentally as a means of regulating corporate behavior, an alternative to tax incentives, mandates, or direct subsidies

Evolving Executive Equity Compensation and the Limits of Optimal Contracting

Executive equity compensation in the United States is evolving. At the turn of the millennium, stock options dominated the equity pay landscape, accounting for over half of the aggregate ex ante value of senior executive pay at large public companies, while restricted stock and similar compensation accounted for only about ten percent. Beginning in 2006, stock grants have displaced options as the single largest component of senior executive compensation at these firms. Accompanying this shift has been increased variation among companies in their relative emphasis on stock and options in equity pay packages. Both phenomena provide an opportunity for a rich exploration of executive pay contracting focusing specifically on equity pay design. Such an exploration is timely given the current focus in Washington on the relationship between equity compensation and corporate risk taking. This Article begins that exploration and hag two primary aims. First, it describes the evolution in executive equity pay practices and the current equity compensation landscape. Second, it considers the extent to which this evolution and the current use of stock and option pay can be explained as a function of efficient contracting (and what efficient contracting means in this context). The analysis reveals several features of the executive equity pay landscape that suggest limitations on efficient compensation contracting. First, although directionally consistent with changes in the conventional economic determinants of equity pay design, the dramatic shift over the last decade from very heavy reliance on options to a more balanced emphasis on stock and options suggests that option expensing, option taint, and/or increased perceptions of option risk played leading roles. Second, the trimodal distribution of the mix of stock and options being granted in recent years suggests that optimizing incentives is not the sole consideration of issuing firms. Third, the extent to which the same mix of stock and options is granted to the various member of the executive suite suggests that individual optimization is quite limited

Executive Pay Clawbacks and Their Taxation

Executive pay clawback provisions require executives to repay previ¬ously received compensation under certain circumstances, such as a downward adjustment to the financial results upon which their incen¬tive pay was predicated. The use of these provisions is on the rise, and the SEC is expected to soon finalize rules implementing a mandatory, no-fault clawback requirement enacted as part of the Dodd-Frank leg¬islation. The tax issue raised by clawbacks is this: should executives be allowed to recover taxes previously paid on compensation that is returned to the company as a result of a clawback provision? This Arti¬cle argues that a full tax offset regime is most in keeping with the evolving rationales for clawbacks, with consistent treatment of execu¬tives subject to clawbacks, with encouraging even-handed implemen¬tation of clawbacks, and with minimizing clawback-induced distortions and other unintended consequences associated with a tax regime that would not provide full offsets. But the tax treatment of clawback pay-ments has been uncertain, and the enactment of the Tax Cuts and Jobs Act adds to that uncertainty. Meanwhile, adoption of legislation to ensure that executives are fully compensated for taxes previously paid on recouped compensation is probably a political non-starter. Given that, this Article argues that the IRS and courts should interpret the relevant tax laws liberally to maximize recovery of taxes paid on clawed back compensation

Who Bears the Cost of Excessive Executive Compensation (and Other Corporate Agency Costs)?

Managerial agency costs are ubiquitous in the modern public corporation. Agency costs arise from the separation of ownership and control and reflect the divergence between share-value-maximizing actions of managers and managers’ actual actions, plus the monitoring and bonding expenditures (including contracting costs) undertaken to reduce that divergence. Agency costs vary firm by firm, but regulatory actions and even business practices can have a systematic impact on agency costs. For example, increased or decreased enforcement of insider trading rules can affect agency costs across a wide spectrum of companies. Who bears the burden of corporate agency costs? Who gains or suffers when agency costs rise or fall systematically? To the extent that corporate governance experts have considered this question, they have assumed, explicitly or implicitly, that shareholders bear these costs as the recipients of residual corporate returns