One of the most popular executive perks during mergers and acquisitions is the so-called tax gross-up, which is a payment made by company's to cover taxes on an executive's severence package. Given today's tax law, these gross-ups can end up costing shareholders almost as much as the severence packages themselves! For example, when SBC boughtout rival AT&T in 2005, CEO David Dorseman received not only a $29 million severence package but an additional $11 million gross-up to cover taxes. These gross-ups often go under the radar, unnoticed by the majority of shareholders. Many shareholder rights groups call these gross-ups the most costly part of a golden parachute and an extremely inefficient use of shareholder money. Consequently, it will likely be a popular topic during this years proxy season.

Gross-ups first gained their popularity during the 1980's merger frenzy after the government imposed new tax penalties on executives aimed at preventing them from cashing out million by quickly selling their companies and unloading all of their shares. Companies then began offering gross-ups as an incentive to help keep and retain executives. According to an article on BusinessWeek, only 10% of companies in 1987 had gross-ups compared to about 77% now. It is becoming increasingly apparent that government regulations intended to help reduce executive compensation are simply costs that are passed on to shareholders...

Aflac, Inc. (NYSE:AFL) became the first company to offer shareholders a non-binding vote on executive compensation packages. The move came in response to a 2006 shareholder proposal aimed at increasing corporation transparency and accountability. "Our shareholders, as owners of the company, have the right to know how executive compensation works", commented the company's CEO. "The board's action is in keeping with Aflac's longstanding pay-for-performance compensation policy and our commitment to transparency at all levels."

The company created an offer last week that will give shareholders the ability to cast their votes on the company's 2009 proxy. While the shareholder vote on pay packages serves only as an advisory vote as of now, it creates an important venue for shareholders to communicate on the issue of executive compensation. And with over forty companies are facing shareholder resolutions on executive pay this 2007 proxy season, this may become a new trend to help satisfy the increasing concerns over compensation packages.

A new study by the University of Texas has found that CEO’s at companies whose directors sat on numerous other boards were paid 13% more than CEO’s whose directors did not sit on other boards.  The study is a reflection of sorts of outside directors, most of whom often sit on several boards.

There are several possible explanations.  Some argue this is evidence of the power of "friend of friend" networks that facilitate mutual back-scratching.  Others argue that it is evidence of a viral spread of self-serving practices.  Simply put, it allows a board member, with a reputation for supporting CEO’s, to get other jobs.  An outside director that is friendly to CEO’s on one board gets selected by other CEO’s for other board positions. 

This study, involving 3,000 companies, shows that companies lavishly pay CEO’s even while performing below expectations for such high pay.  This has also been noticed by more than 80% of Americans (evenly divided between the well-off and those making under $100,000-a-year) who agree that CEO’s are paid too much.  The greater the bond between CEO’s and board members creates greater compensation packages, plain and simple.  

Grants of restricted stock are not inherently performance-based. This is due to the fact that the executive may receive compensation even if the stock price decreases or stays the same. A grant of restricted stock is treated like cash and does not satisfy the definition of performance-based compensation, unless the grant of the restricted stock is solely based upon the attainment of a performance goal or standard (set by the compensation committee and/or shareholders). While not overly common, restricted stock is one way in which many executives are "quietly" compensated by effectively tendering stock into cash.

Performance-based compensation is a growing trend among compensation procedures. It is currently being acted upon as "pay for play" theories where compensation accounts for the attainment of one or more performance goals within the company. These performance goals are established by a compensation committee consisting solely of two or more outside directors (not a current or former employee or officer of the corporation,and does not recieve compensation for personal services other than for directorship). The material terms under which the compensation is to be paid, including the performance goals, are then disclosed to and approved by the shareholders in a separate vote prior to the payment. The committee verifies that the performance goals and any other material terms have been successfully met and completed in order for the executive to receive the full compensation.

Performance is based on standards for the individual executive, for a particular branch, or for the company as a whole. Performance standards could include increases in stock price, market share, quarter or annual sales, or earnings per share. Please note that executives are allowed some discretion in their performance-related compensations; as well, their performance may be reevaltuated based on preestablished objective goals and performance formulas.

Two pension funds (one public) said that they would ask an Alaska state court to freeze more than $140 million in retirement pay and other compensation for outgoing BP CEO John Browne, saying it is "excessive and undeserved". The shareholders said they want Mr. Browne's pension fund to be held in a court-supervised trust while they pursue claims against him and the board of directors for environmental and worker safety issues that have beset the oil company. They are also pushing for future executive compensation at BP to be tied to safety metrics in an attempt to curb the recent rise in public health and safety concerns, including fatal accidents at a Texas refinery and maintenance issues at an Alaskan oil pipeline.

The claims, according to estimates compiled by the plaintiff's law firm, seek to temporarily bar Mr. Browne from collecting approximately $40 million in pension benefits and $54.5 million in long-term performance pay while the plaintiffs pursue their claims. They also want the court to freeze about $30.7 million in stock options and want about $18.3 million in previously awarded cash bonuses to be returned and put into the trust. Finally, the group demanded company accounting records that they could use to calculate the exact total of his compensation. While BP refused to comment on the matter, we already know that the CEO announced that he would be stepping down on at the end of July, a full year-and-a-half earlier than expected.

Deferred compensation is exactly what it sounds like: compensation that is deferred until a later date. Why would someone defer their compensation, especially given the time value of money? Well, it turns out that the government offered many tax benefits for those who did defer their compensation. Consequently, executives sought to defer large amounts of compensation as a way to avoid paying taxes. Recently laws have reversed this trend, however, by placing a $1 million cap on all deductions.

Under the new laws, a corporation may deduct compensation expenses as an ordinary and necessary business expense for its employees. However, the otherwise acceptable deduction for compensation paid or accumulated to a covered employee of a public corporation is limited to no more than $1 million a year. A person is considered a covered employee if they are the CEO of a corporation (or the individual acting in such capacity) at the close of the taxable year; as well, the four highest compensated employees are also taken into account for the limitation's rules.  

The deduction limitation is applied even in the case of an emergency resulting from transfer of property in connection with the performance of services. The deduction limitation applies to all compensation for services, including cash and the cash value of all remuneration (including benefits) paid in medium other than cash. There are a few factors that are not included in the deduction limitation. Such factors not included are remuneration based on commission; remuneration payable solely on account of the attainment of one or more performance goals if certain outside director and shareholder requirements are met (performance-based compensation); payments to a tax-qualified retirement plan (including salary deduction contributions); and amounts that are excludable from the executive's gross income (such as health benefits and miscellaneous fringe benefits). 

Executives are covered by a wide range of compensation arrangements, which will be discussed in our new series. These arrangements may include agreements between several employees or it may consist solely on individual agreements between the company and one executive. Typical arrangements include nonqualified deferred compensation and stock option programs due to their tax benefits. There is, however, a limit on a company's deduction for compensation of certain employees in excess of $1 million - a limitation that applies to the chief executive officer and the four other most highly compensated employees. However, performance-based compensation is not subject to the deduction limitation. Studies have indicated that the deduction limitation may have led to some substitution away from salary compensation toward performance-based compensation, but that growth in overall executive compensation has not been reduced.

Our series will primarily explore the various types of stock-based compensation, which includes stocks, stock options (right to purchase shares by a certain date), restricted stock (stock with restrictions tied to them, such that can't be sold for a certain amount of time, etc.), stock appreciation rights (the right to the gains of the stock as if you owned it), and phantom stock (artificial shares that the company values at the going market rate).