Special Report

THAT'S SOME PAY CAP, BILL

The people who make a living designing those super-rich pay packages for top executives are having a hearty laugh these days at Washington's expense.

By imposing a $1 million cap last year on the amount of executive pay that is deductible, President Clinton and Congress had hoped to put the brakes on excessive compensation. The law, however, is having some unintended consequences--to say the least. "President Clinton has created a minimum wage for CEOs," declares Arnold S. Ross, a New York consultant who designs pay packages for executives. "A $1 million base salary is now the gold standard."

He and other consultants say companies that used to pay their CEOs less than $1 million are now upping the ante to the level of the cap (table). Meanwhile, many others that are already paying their executives more than $1 million are largely ignoring the new rules, choosing to fork over higher taxes instead.

It shouldn't come as much of a surprise, considering what happened when legislators imposed limits on the golden parachutes of the early 1980s. Dubbed by many the "Bill Agee" bill, in honor of the Bendix chief executive who pulled the ripcord on a $5.4 million parachute, the law imposed penalty taxes on companies that handed out overly generous severance packages. Any golden parachute exceeding 2.99 times the average annual pay of an executive over the previous five years was subject to the penalty tax.

"INFINITE WISDOM." The upshot: A law that was intended to limit the use of parachutes has created something of a standard. Many companies with then-typical parachutes that paid one year's salary quickly raised them to exactly the 2.99 figure. Other companies that never had golden parachutes quickly put them into effect for their executives. "Directors said: `Why should we question the infinite wisdom of Congress? If Congress is saying that's reasonable, why not?"' says Peter Chingos, who heads the executive-pay practice at KPMG Peat Marwick.

A decade later, the government's effort to put a damper on executive salaries is also having the opposite of its intended effect. Philip Morris Cos., for example, paid CEO Michael A. Miles exactly $1 million in base pay last year, up from $950,000 a year earlier. The company's explanation? The hike occurred only because "of salary increases that became effective" in mid-July of 1992. Dun & Bradstreet Corp., meantime, raised the salary of its chief executive, Charles W. Moritz, by 6.4% last year to $988,615--just $11,385 below the cap.

The new law limits the deductibility only of pay that isn't linked to some specific measure of performance, such as shareholder returns or return on equity. Many companies that are already over the $1 million mark are piling on performance-related compensation that qualifies for the deduction. They're seeking shareholders' approval of new plans that would allow them to continue to deduct most of the pay they dish out to executives. The shift to performance-related pay is one relatively favorable outcome of the new law--along with a requirement that such plans be proposed by compensation committees composed of independent, outside directors.

But even in these cases, there's a new, unintended wrinkle: Some companies are creating generous bonus formulas that will likely push incentive pay higher. The reason is that the directors now have less discretion to pay what they want if bosses happen to miss their mathematical targets. So boards are setting easier hurdles for payouts and increasing the pool of money that's available for bonuses. "There will be lower thresholds and higher maximum payments," says consultant Pearl Meyer. "Over time, pay levels are going to creep up just because ef this."

HATE THE MEDDLING. Another way to comply with the new cap, of course, is simply to cut executive pay outlays. Not surprisingly, few if any boards have taken that route. Indeed, many companies publicly chose not to restructure all their executive pay plans to qualify for the deduction, preferring instead to hand over higher corporate taxes. The reason: They resent government meddling in their decision to set pay. A survey of 100 top companies by Pearl Meyer & Partners Inc. in New York found that one-third have one or more pay plans that don't qualify, while an additional third are still studying the matter.

Bethlehem Steel Corp., for example, will continue granting restricted stock to its executives, even though the awards fail to qualify for the deduction. Union Carbide Corp. decided against qualifying its cash plans. Eli Lilly & Co. declined to alter its annual incentive plan for top executives. The company said it wanted to retain the flexibility to reward executives as it sees fit.

As a result, the $1 million cap, far from curbing executive pay, actually penalizes shareholders. Rather than allowing Uncle Sam to set pay levels, many companies are opting to pay extra taxes--which come out of earnings. "It's a good example of the perverse effects you can get when you try to use the tax code to dictate policy outcomes," says James E. Heard, chief executive of Institutional Shareholder Services Inc., which advises large investors on corporate issues. When it comes to the notion of a $1 million minimum wage, perverse may be an understatement.TABLE: MAKE IT AN EVEN MILLION

Here's a sampling of CEOs whose salaries rose to exactly $1 million last year in the wake of a new law capping the corporate tax deduction on executive pay:

Executive Company 1992 salary 1993 salary

ECKHARD PFEIFFER Compaq $921,400 $1,000,000

CHARLES B. WANG Computer Associates Intl.750,000 1,000,000

LAWRENCE J. ELLISON Oracle Systems 900,000 1,000,000

A.J.C. SMITH Marsh & McLennan 893,750 1,000,000

MICHAEL A. MILES Philip Morris 950,000 1,000,000

DATA: COMPANY REPORTS

RAY VELLA/BW

John A. Byrne in New York