Employer Losses and Deferred Compensation

Abstract

Most large public companies offer their executives the opportunity to defer the receipt and taxation of a portion of their salary or other current compensation until retirement or some other future date, and equity compensation, which also entails deferral of pay and taxation, constitutes a large fraction of the typical executive pay package. Conventional wisdom holds that employer net operating losses (NOLs) improve the joint economics of deferred and equity compensation (henceforth together "deferred compensation") for the parties. However, empirical studies provide little evidence of an association between employer NOLs and deferred compensation use. This paper focuses on two potential explanations for this apparent disconnect. First, this paper shows that the relationship between employer NOLs and the attractiveness of deferred compensation is more complex and less predictable than is generally recognized, that a larger NOL position does not necessarily produce a larger driving force for use of deferred compensation, and that in some cases employer NOLs can actually result in poorer deferred compensation economics. As a result, some employers and executives may rationally choose to ignore employer NOLs when making compensation decisions. Second, even if companies are sensitive to the existence of employer NOLs when making compensation decisions, it is not clear that research methods currently in use would detect the sensitivity. The commonly used proxies and simulations of employer effective marginal tax rates that have been employed in these studies may not adequately capture the complexity of the relationship between NOLs and the economics of deferred compensation. * Professor of Law and Maurice Poch Faculty Research Scholar, Boston University School of Law. Acknowledgments to follow. Draft of July 31, 2019. Please do not cite without author's permission. Equity--Based CompensationThe most important and noticeable change in equity--based pay over the past two decades has been the declining use of stock options and offsetting increased use of performance share awards. 63 In 1990, options accounted for over 60% of the total ex ante value of compensation granted to the median S&P 500 senior executive. In 2013 options accounted for less than 20%, while performance awards accounted for over 30%. 64 This transformation has had a significant impact on deferral periods. While options are typically exercisable for ten years, and typically exercised within five or six years, performance awards typically cover a three--year period. 65 To the extent that performance share awards have displaced options, the deferral period associated with equity pay has been reduced by about half.To be sure, start--ups remain somewhat more likely than mature public companies to issue options, and start--ups are more likely to be in an NOL position, but NOLs are by no means limited to start--ups. 66