Order Code RS22604
Updated May 8, 2007
Excessive CEO Pay:
Background and Policy Approaches
Gary Shorter and Mark Jickling
Government and Finance Division
Alison Raab
Knowledge Services Group
Summary
During the past several decades, average pay for non-management workers has
stagnated; after adjustment for inflation, there has been no increase since the early
1970s. In contrast, compensation of top corporate executives has risen dramatically.
Supporters of current CEO pay levels argue that executive compensation is determined
by normal private market bargaining, that rising pay reflects competition for a limited
number of qualified candidates, and that even the richest pay packages are a bargain
compared with the billions in shareholder wealth that successful CEOs create. Others,
however, view executive pay as excessive. Some see a social equity problem, taking
CEO pay as symptomatic of a troublesome rise in income and wealth inequality. Others
see excessive pay as a form of shareholder abuse made possible by weak corporate
governance structures and a lack of clear, comprehensive disclosure of the various
components of executive compensation. This report describes the major legislative and
regulatory proposals that have sought to remedy these perceived problems, including
H.R. 1257 (Representative Frank), which the House passed on April 19, 2007, and
would require that CEO pay packages be put to a nonbinding shareholder vote. S. 1181
(Senator Obama), a companion bill, was subsequently introduced in the Senate. The
report will be updated as events warrant.
Background
Publicly traded corporations — those required to file financial statements with the
Securities and Exchange Commission (SEC) — must in their annual proxy statements
disclose the total compensation of the five highest-paid executives. These data, as
compiled by various publications, consultants, and information vendors, comprise the
basis for all public statistics on executive compensation. Other than the top five
individuals, corporations generally provide no information about management pay.

---

CRS-2
Most accounts of executive compensation are not based on comprehensive statistics,
but on samples. For example, Business Week for many years published tables of CEO pay
at 300 or 400 large corporations. These figures (which are presented in CRS Report 96-
187, A Comparison of the Pay of Top Executives and Other Workers, by Linda Levine)
show that the ratio of average CEO pay to average non-management worker pay rose from
50:1 in 1980 to 349:1 in 2004. This raises the question of whether public shareholders
(who are CEOs’ employers) get their money’s worth?
The results of the numerous academic studies of the relationship between CEO pay
and corporate performance are mixed. Few would dispute Warren Buffett’s claim that
“...it’s difficult to overpay the truly extraordinary CEO of a giant enterprise. But this
species is rare.”1 More controversial, but not without support in the empirical literature,
is his additional observation:
Getting fired can produce a particularly bountiful payday for a CEO....Forget the old
maxim about nothing succeeding like success: Today, in the executive suite, nothing
succeeds like failure.2
This may be why CEOs attract more resentment and criticism than wealthy athletes,
movie stars, or entrepreneurs — their pay often goes up even when their performance is
mediocre or worse, and they preside over organizations created and maintained by others,
where their personal contributions are not always easy to discern. The perception that
many, if not all, top executives are overpaid leads to questions about the compensation
process.
CEOs serve at the pleasure of the board of directors, who represent the interests of
— and are elected by — shareholders. Executive pay is set by the board. In principle,
boards should bargain on the shareholders’ behalf, creating a competitive market for
executive services. However, there are several reasons why this might not happen.
Directors are elected by shareholders, but usually nominated by management, and
it is extremely rare for management’s slate of directors to be voted down. According to
various observers, once on the board, directors are reluctant to press managers on pay
because unless cordial relationships prevail, the board will find it difficult to function.3
Rather than haggle, they often hire compensation consultants, who recommend a “best
practices” approach, which generally means matching what the most successful
companies in the industry pay. Finally, many directors are themselves serving or retired
CEOs.
Thus, there is a widespread belief that the market for chief executives is
economically inefficient and that market discipline weakens as one nears the top of the
corporate pyramid. As a consequence, many argue that CEOs have been the beneficiaries
1 “To the Shareholders of Berkshire Hathaway Inc.,” Berkshire Hathaway 2005 Annual Report,
p. 16.
2 Ibid.
3 This would help explain why CEO pay never seems to fall even though polls show that
significant numbers of directors believe CEOs are overpaid: no one wants to be the first to cut
pay.

---

CRS-3
of substantial pay packages at the expense of the 54 million American families who own
corporate stock.4 In turn, fueled by recurrent publicity over especially lucrative salaries,
stock windfalls, retirement benefits, or severance payments, these concerns have
prompted a range of legislative and regulatory responses.
Key Regulatory and Legislative Developments
There have been two general approaches to executive pay reform. First, changes to
securities laws and regulations have attempted to strengthen the bargaining position of
shareholders by (1) requiring more complete and comprehensible disclosure of CEO pay,
(2) making boards more responsive to shareholder interests, or (3) requiring a shareholder
vote on executive pay packages. Second, Congress has tried to restrain the growth of
executive pay by eliminating the tax deduction for compensation paid in excess of
specified caps.
Disclosure-Based Approaches. The requirement that publicly traded
companies disclose how much they pay top executives dates from the 1930s. The SEC
has modified the disclosure format several times, as the forms of CEO pay have become
more various and complex. In 1992, the SEC required that proxy statements include
tables setting out several categories of pay for the top five executives. These included
base salaries, bonuses, deferred, and incentive-based compensation, including stocks and
stock options.
SEC 2006 Disclosure Rules. By 2006, the SEC had concluded that the 1992
disclosure rules were, in the words of SEC Chairman Christopher Cox, “out of date....
[They] haven’t kept pace with changes in the marketplace, and in some cases disclosure
obfuscates rather than illuminates the true picture of compensation.... We want investors
to have better information, including one number — a single bottom line figure — for
total annual compensation.” In addition, the SEC called for changes that would require
firms to use “plain English” in all their proxy statements, information statements, and
annual reports.5
To this end, the SEC amended its disclosure rules in 2006 to combine what it called
a “broader -based tabular presentation with improved narrative disclosure supplementing
the tables” in order to give shareholders and board members a “fuller and more useful
picture of executive compensation.”6 Announced on July 22, 2006, further amended on
December 22, 2006, and currently under consideration, the revisions would apply to
disclosure in proxy and information statements, periodic reports, current reports and other
4 The Federal Reserve’s Survey of Consumer Finances reports that in 2004, 48.6% of 112.1
million U.S. families owned stock, either directly or through a retirement account.
5 Christopher Cox, “Speech by SEC Chairman: Chairman’s Opening Statement; Proposed
Revisions to the Executive Compensation and Related Party Disclosure Rules,” January 17, 2006,
[http://www.sec.gov/news/speech/spch011706cc.htm].
6 “Executive Compensation and Related Person Disclosure,” Federal Register, vol. 71, no. 174
(September 8, 2006),p. 53160; “Executive Compensation Disclosure,” Federal Register, vol. 71,
no. 250 (December 29, 2006), p. 78346.

---

CRS-4
filings under the Securities Exchange Act of 1934, and registration statements under the
Exchange Act and the Securities Act of 1933.7
The new and revised tables in the 2006 rules include a
! Revised Summary Compensation Table, which was changed to include
a “Total” column aggregating the total dollar value of each form of
compensation quantified in the other columns;
! New Director Compensation Table, which resembles the new Summary
Compensation Table, but differs in that it requires companies to present
information only with respect to the last completed fiscal year; and
! New Grants of Plan-Based Awards Table, which requires companies to
disclose information on the fair value of the awards on the day of the
grant.
For stock awards and option awards reported in the Summary Compensation Table
and Director Compensation Table, the SEC initially required in its July 2006 rules that
companies report the total value of an award made in a given year. The December
amendments revised that requirement, specifying that companies had to report in the
tables only the portions of the awards that vest in the year to which the proxy applies.8
In addition, the December 2006 amendments require companies to include footnotes in
its Director Compensation Table corresponding to the Grants of Plan-Based Awards
Table fair value disclosures.
In addition to the new and revised tables, the SEC introduced new rules for narrative
disclosure. The narrative disclosure is intended to aid in the understanding of the tabular
information. For example, with the Summary Compensation Table, companies must
provide information on the material terms of each grant, “including but not limited to the
date of exercisability, any conditions to exercisability, any tandem feature, any reload
feature, any tax-reimbursement feature, and any provision that could cause the exercise
price to be lowered.”9
Shareholder Approval. Under H.R. 1257 (Representative Frank) and S. 1181
(Senator Obama), which are both entitled the Shareholder Vote on Executive
Compensation Act, proxy statements shall permit a separate shareholder vote to approve
executive compensation as disclosed in the proxy. The shareholder vote would not be
binding on the board of directors; the board could choose to ignore an unfavorable vote,
7 “Executive Compensation and Related Person Disclosure,” Federal Register, vol. 71, no. 174
(September 8, 2006), p. 53158.
8 The SEC explained its December 2006 revisions thus: “Disclosing the compensation cost of
stock and option awards over the requisite service period will give investors a better idea of the
compensation earned by an executive or required disclosure of the sum of the number of
securities underlying stock options granted (including options that subsequently have been
transferred), with or without tandem stock appreciation rights (SARs), and the number of
freestanding SARs.” “Executive Compensation Disclosure,” Federal Register, vol. 71, no. 250
(December 29, 2006), p. 78338.
9 Ibid., p. 78343. For more on the SEC rules, see CRS Report RS22583, Executive Compensation:
SEC Regulations and Congressional Proposals, by Michael V. Seitzinger.

---

CRS-5
though it is unlikely that they would do so. The bill also would require proxy statements
related to a corporate merger or acquisition to include clear and simple disclosure of any
new “golden parachute” plans, or severance pay arrangements whereby top executives
receive extra compensation when the corporation is merged or acquired by another firm.
A separate, nonbinding shareholder vote on golden parachutes would be required.
On April 19, 2007, H.R. 1257 was approved by the full House.
The following legislative and regulatory developments have also affected CEO pay,
although that was not their primary focus.
The Sarbanes-Oxley Act of 2002 (P.L. 107-204). Enacted in the wake of
widespread accounting scandals at firms such as Enron and WorldCom, P.L. 107-204
contains a broad range of corporate governance and accounting reforms, some of which
are relevant to executive pay. Section 403 of the act requires insiders (defined as officers,
directors, and 10% shareholders) to file with the SEC reports of their trades of the issuer’s
stock before the end of the second business day on which the trade occurred. This
provision applies to grants of stock options, a major form of executive compensation.
Previously, option grants did not have to be disclosed until 45 days after the end of the
fiscal year.
Section 402 of the law makes it unlawful for a public company to make loans,
directly or indirectly, to any director or executive officer.
Changes in NYSE and Nasdaq Listing Standards. In 2003, the SEC
approved changes to the listing standards of the New York Stock Exchange (NYSE) and
the Nasdaq Stock Market that require shareholder approval of almost all equity-based
compensation plans. Firms must disclose the material terms of their stock option plans
prior to the shareholder vote. The required disclosures include the terms on which stock
options will be granted and whether the plan permits options to be granted with an
exercise price that is below the market value of the company’s stock on the date of the
grant.
FASB’s Options Accounting Rule. In 2004, the Financial Accounting
Standards Board (FASB), a private sector entity that writes accounting standards under
the authority of the SEC, released accounting directive FAS 123R, which requires
companies to recognize the value of employee stock option grants in their income
statements. (Previously, most companies had simply noted the value of options grants in
the footnotes to the financial statements.) Recognition of the cost of options has the effect
of reducing reported earnings. Companies may reduce this impact by granting fewer
stock options to their officers and employees. Thus, FAS 123R may have constrained
executive pay even though that was not its primary intent.
Approaches Involving Caps on Tax Deductibility. The second approach to
CEO pay reform is to discourage excessive compensation through the tax code, by
limiting the deductions available to either the firm or the employee when certain caps are
exceeded. While companies may generally deduct all employee compensation from
taxable income, various legislative proposals and enacted legislation place limits on the
tax deductibility of certain forms and amounts of pay. Several examples are described
below.

---

CRS-6
The Omnibus Budget Reconciliation Act of 1993 (OBRA). P.L. 103-66
established code section 162 (m), “Certain Excessive Employee Remuneration,” which
imposes a $1 million cap that applies to the CEO and the four next-highest-paid officers.
No tax deduction for compensation above the $1 million limit is permitted, except for
“performance-based” pay, such as commissions or stock options, where the ultimate
compensation received by the executive depends on the stock price, reported sales or
profits, or some other financial indicator.
The OBRA provision is widely believed to have contributed to the increased use of
stock options in CEO compensation in the mid- and late 1990s.10 To the extent that this
is true, OBRA may have had the unintended consequence of increasing CEO pay.11
Income Equity Act. Former Representative Martin Olav Sabo introduced
legislation in several Congresses (e.g., H.R. 3260, 109th Congress) to deny a corporate tax
deduction for compensation paid to any individual that was in excess of 25 times the
compensation received by the lowest-paid full-time employee of the company. None of
these bills was reported out of committee.
H.R. 2 (Senate Version). The version of H.R. 2 (the minimum wage bill) passed
by the Senate on February 1, 2007, by a vote of 94-3, included several tax provisions, one
of which applies to executive pay. Current tax rules permit individuals to defer taxes on
income that is held in nonqualified deferred compensation plans. Under the Senate
version of H.R. 2, an individual could defer no more than $1 million annually from
taxable income by contributing to such a plan.12 The version passed by the House on
January 10, 2007, had no similar provision.
crsphpgw
10 Other factors, such as the wave of public offerings by cash-poor technology firms and the bull
market itself, also increased the popularity of options during the 1990s.
11 For example, see the “Testimony Concerning Options Backdating,” by Christopher Cox,
Chairman, SEC, before the U.S. Senate Committee on Banking, Housing and Urban Affairs,
September 6, 2006.
12 Joint Committee on Taxation, Description of the Chairman’s Modification of the Provisions
of the “Small Business and Work Opportunity Act of 2007” (JCX-5-07), January 17, 2007, p. 25.

---