Bloomberg Businessweek: Companies Use IRS to Raise Bonuses With Earnings Goals:
After Exelon Corp. earned less than top executives needed to reach their annual cash bonus target last year, the company's directors provided a way to help bridge the gap: nonexistent profits.
The board tacked on 6 cents a share -- equal to $85 million -- that the Chicago-based power company never made, augmenting earnings solely for the purpose of calculating bonuses. Exelon said that it would have earned the sum except for a regulatory setback on electricity rates and that the pennies helped thousands of employees avoid smaller payouts.
The 6 cents helped executives receive their fourth above-target bonus in five years as the company’s operating profits and its market value fell by more than half. Amid the slide, the board awarded more than $20 million in cash bonuses to top managers as tax-deductible “performance-based pay."
Exelon and dozens of other corporations demonstrate how such tax-advantaged bonuses -- which cost the U.S Treasury $3.5 billion a year, according to the congressional Joint Committee on Taxation -- can reward even subpar shareholder returns. Chief executive officers at 63 companies in the Standard & Poor’s 500 Index got cash incentive-pay increases last year after their share returns underperformed the index’s, according to data compiled by Bloomberg. ...
Even companies with robust income amplify executives’ cash bonuses by setting comparatively low targets, Bloomberg data show. Since 2006, Marsh & McLennan, Valero Energy and Walt Disney, among others, repeatedly paid above-target bonuses after setting profitability goals below analysts’ expectations, often by 5 to 10 percent or more. Disney pegged management’s targets below average analyst estimates each year since 2007, the data show.
Directors at 74 of the S&P companies set targets lower than Wall Street analysts’ average earnings estimates at least half the time since 2006, according to data compiled by Indiana University researchers [Behind the Scenes: Performance Target Setting of Annual Incentive Plans]. ... Significant gaps between analysts’ estimates and bonus goals may mean directors are “deliberately setting performance targets low so the management doesn’t have to meet market expectations in order to get paid,” said Robert Jackson Jr., a Columbia University law professor who helped the federal government oversee executive pay at companies bailed out during the financial crisis....
At issue is a 1993 federal law [I.R.C. § 162(m)] that capped tax deductions that public companies take for top executives’ pay at $1 million each. Former President Clinton, who proposed the limit, agreed to exempt performance awards. After Congress enacted the measure, it was left to the IRS to enforce. The IRS created rules so vague that any company can define performance “more or less as it chooses,” said Michael Doran, a lawyer in the Treasury’s Office of Tax Policy under Clinton and former President George W. Bush. Doran, now a Georgetown University law professor, favors making all compensation tax-deductible and said the current rules have merely served to undermine the concept of “performance.” “Officers can receive payments that satisfy the exemption even if the stock price is falling, revenues are falling and earnings are falling,” Doran said. “Failure can be treated as success for purposes of the exemption.”