When Congress tries to fix leaks in executive pay regulation, it may create new leaks, a finance professor warned lawmakers today.
Kevin Murphy, a professor of business, law and economics at the University of Southern California, appeared at a House Financial Services Committee hearing on the relationship between compensation structure and systemic risk.
No witnesses referred directly in their written testimony to life insurance, disability insurance or annuity arrangements, but several referred to supplemental retirement packages.
Murphy noted that Congress created Section 409(A) of the Internal Revenue Code with a provision of the American Jobs Creation Act of 2004, in an effort to address concerns that Enron Corp., Houston, let a small number of employees withdraw millions of dollars from deferred compensation accounts just before the company filed for bankruptcy.
“In essence, the objectives of Section 409(A) were to limit the flexibility in the timing of elections to defer compensation in nonqualified deferred compensation programs, to restrict withdrawals from the deferred accounts to pre-determined dates (and to prohibit the acceleration of withdrawals), and to prevent executives from receiving severance-related deferred compensation until six months after severance,” Murphy testified, according to a written version of his remarks.
Section 409(A) imposes taxes on individuals with deferred compensation as soon as the amounts payable under the plan are no longer subject to a “substantial risk of forfeiture,” and, if individuals fail to pay taxes on those amounts, the amounts are subject to a 20% excise tax and interest penalties, Murphy said.
In the real world, “Section 409(A) restricts compensation committees from offering many incentive arrangements that are in the best interest of shareholders,” Murphy said. “Such options are often in the interest of shareholders, especially when employees ‘purchase’ the discount options through explicit salary reductions or outright cash exchanges.”