Regulation 162(m) is a part of the IRS tax code that restricts tax deductibility of the five highest-paid executives in a public company to $1 million. Bill Clinton was the one who instituted this change in the tax code that was intended to curb executive compensation; however, it had some major flaw - it didn't apply to "performance-based" compensation. This caused the entire plan to backfire as the government and shareholders lost billions more while executives made out with more than ever before.

How did companies get around the regulation? Instead of paying executives the majority of their salary in standard compensation, companies began expensing stock options, LTIPs (long-term incentive plans), perks, and other bonuses that were based on low "performance-based" standards. They passed this by shareholders by tying down these performance metrics to many intangible factors that the company could inflate, such as customer satisfaction, diversity, and customer service. Moreover, they were released in obscure 8K filings with the SEC that normal investors rarely check. And to put the nail in the coffin, neither the SEC nor the IRS evaluate or check over these metrics - so it is impossible to tell if the company is being truthful. Sometimes targets aren't even defined, and in some cases can be as vague as tying compensation to "individual achievement of personal commitments"!

As a result of Reg 162(m), the government has lost out on roughly $20 billion in tax revenues while investors were stuck with extensive share dilution as executive compensation levels skyrocketed yet again to their highest levels ever. In 1980 the average executive earned only 40x what a normal worker would; now, executives make approximately 400x as much as a normal worker! Finally, in September, The Senate Finance Committee acknowledged the fact that they made a mistake, and is now evaluating other possible solutions. Whether or not they will come up with something effective remains to be seen; however, it is becoming increasingly important for investors to watch executive compensation levels.