A new study co-authored by an associate professor at the Indiana University Kelley School of Business, says a provision of the Tax Cuts and Jobs Act of 2017 did little to effect CEO pay. The legislation repealed a nearly 30-year-old exemption that allowed companies to deduct performance-based pay for executives, with the idea that companies would move away from performance pay to cash-based fixed compensation. The study found that after the repeal, CEO pay either stayed the same or increased.
Bridget Stomberg, associate professor of accounting at the Kelley School, tells Inside INdiana Business the study looked to see if Congress achieved what it intended to do.
“We were looking for a reduction of performance pay, an increase in salary, and then third, if you give an executive or anybody more guaranteed pay, then the total level of pay should go down,” said Stomberg. “So we were looking to see a decrease in performance pay, a decrease in total pay, and an increase in salary. And we really didn’t find any evidence of that.”
The study, “Examining the Effects of the Tax Cuts and Jobs Act on Executive Compensation,” was co-authored by Lisa De Simone, an associate professor of accounting at the University of Texas’ McCombs School of Business, and Charles McClure, an assistant professor of accounting at Booth.
It was published online by the journal Contemporary Accounting Research. You can read the full article by clicking here.
Stomberg says in the mid-1990s, Congress capped the amount of executive compensation that a public company could deduct in a year at $1 million, with the exception of performance-based pay.
“So essentially, what that did was it allowed companies to deduct an infinite amount of performance based compensation like stock options,” she said.
The 2017 legislation, in addition to reducing the corporate tax rate from 35% to 21%, removed the exemption for performance-based compensation.
The study examined changes in executive compensation from fiscal years 2017 to 2018, when the new tax rules took effect. The researchers then looked at compensation in 2019 and 2020.
“Even three full years after the law took effect, we didn’t see any evidence of a reduction in CEO pay,” Stomberg said.
Stomberg says she and her co-authors believe the legislation as an example of Congress perhaps overestimating the tax motivations of public companies. She says there are several sound non-tax reasons why a company would use performance pay and stock-based compensation, including aligning executives’ incentives with shareholders and the fact that it doesn’t require cash.
The authors believe the results of the study could also have an impact on other avenues of curbing executive compensation, such as an excise tax related to CEO pay ratios, or the difference in pay between CEOs and the median worker, which has already been implemented in cities such as Portland, Oregon and San Francisco.
“If Congress’ fundamental assumption about the relative importance of taxes in the design of executive compensation is overstated, its ability to shift current compensation practices through changes in tax policy is also likely overstated,” the authors said. “As a consequence, policymakers should reconsider whether changes to the taxation of executive compensation are a viable path towards addressing the perceived issues of excessive executive pay and inequality.”