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Tuesday, August 05, 2008

The Next Worry: Executive Pensions

As if the economy didn’t have enough to worry about already, the Wall Street Journal published a story on August 4, 2008 (#1) concerning another compensation and cash management practice we are sure to be reading more about in the next few years. The article, entitled Companies Tap Pension Plans to Fund Executive Benefits, identified eleven firms including Intel who have re-structured the books for executive pension plans to shift obligations for those outsized executive plans back into the firm’s rank-and-file pension plan. Understanding the true impact first requires a bit of background, which the article outlines nicely.

* tax law encourages firms to operate pension plans for employees by allowing employer contributions to be deducted from corporate income

* the tax code attempts to avoid aiding the creation of outsized pensions for execs by requiring them to be administered separately and providing no tax deduction for contributions

* the tax code doesn’t make careful distinctions between traditional “pension” compensation and other forms of deferred compensation

That last bullet appears to be the daylight between “legal” and “ethical” required to devise techniques that allow firms to obtain the tax advantages for compensation that would normally run afoul of the “disproportionate” limitations applied for executive benefits. By shifting existing obligations for high paid executives into the rank-and-file pension plan, this approach makes any contributions towards those future deferred compensation payments tax deductible in the present, improving profits (and likely boosting short-term incentive compensation) and disguising the true cost to shareholders of the executive contributions.

The WSJ story only mentioned eleven firms confirmed to have adopted this practice in blending its executive and rank-and-file obligations. However, the story mentioned that because of the accounting for these contributions, it is not easy to identify when the practice is used by reviewing a firm’s books, the IRS doesn’t yet track the practice, and compensation consultants aren’t talking.

Of course, all of the above makes an interesting accounting and management story in and of itself. However, when one considers the health of many pension plans, the current financial health of many large companies and the continuation of lavish compensation for executives producing the current financial morass, alarm bells should be ringing. This risk-shifting practice seems to be one more slight of hand being attempted by possibly dozens of large companies who might be one or two bad news stories away from bankruptcy and a transfer of their pension obligations to an already insolvent Pension Benefit Guarantee Corporation (that’s pronounced “US taxpayer”).

The title chosen for this comment is purely sarcastic. Given the gross overcompensation of the average executive who makes more in one year of work than most Americans can save over a lifetime, no one is really “worried” about their pension plans. The only problem is executives are once again rigging the system to mix their IOUs back in a larger pool of obligations, essentially putting themselves at the head of the line when the company goes bust after having been at the head of the line the whole time while producing the bust.

I’ve suggested before (#2) that one of the most important reforms required in bankruptcy law involves zeroing out all executive pension obligations at bankruptcy. With the outlandish pay received during the good times and often even MORE outlandish “combat pay” offered during tough times to “retain” the “needed leadership”, if executives can’t live on 346x the average worker’s salary (#3), they’re probably part of the problem anyway. This WSJ story provides more evidence of the disconnect between executive incentives and shareholder interests.


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#1) http://online.wsj.com/article_email/SB121761989739205497-lMyQjAxMDI4MTA3NDYwMTQ5Wj.html

#2) http://watchingtheherd.blogspot.com/2006/05/sotu-alternatives-military-retirement.html

#3) http://money.cnn.com/2007/08/28/news/economy/ceo_pay_workers/index.htm