Firms Forfeit Tax Break to Pay Top Brass $1 Million-Plus

By Joann S. Lublin
The Wall Street Journal PAGE B1 on 04/21/1994

Many big businesses have decided to do the unthinkable: forgo a tax break so they can pay their
executives as much as they want however they want. The break stems from the new tax law that
took effect Jan. 1 and that generally bars publicly held corporations from deducting a top officer's
compensation in excess of $1 million a year. Under regulations drafted by the Internal Revenue
Service, that excess would be deductible if the executive's pay is based on objective "performance
goals" drafted by independent directors and cleared at the company's annual meeting.

But rather than seek shareholders' blessing for a certain pay plan or hold senior-executive pay at
$1 million, about a third of 91 big companies will pay what they want and do without the
deduction, concludes an analysis of 1994 proxy statements by consultants Pearl Meyer & Partners
Inc. The number "is many more than we anticipated," says Rhoda Edelman, a partner at the New
York firm. "It is corporate America's way of fighting back at government regulation. They want
the freedom to run their businesses." (Before the new tax law, companies could deduct exorbitant
executive pay without consulting anyone.)

Some companies are getting around the million-dollar deduction cap by having executives defer
some pay until they retire. But others will forfeit the deduction, usually because they oppose
giving outsiders a greater voice in executive-pay decisions. Among them: Eastman Kodak Co.,
Schlumberger Ltd., Gillette Co., Motorola Inc., First Chicago Corp., Martin Marietta Corp. and
Kellogg Co.

At Kellogg, Arnold G. Langbo, chairman and chief executive officer, was paid a salary and bonus
of about $1.3 million in 1993. A spokesman for the Battle Creek, Mich., cereal maker declines to
discuss the decision of the Kellogg board's compensation committee not to alter the company's
pay plans to get the deduction.

Gillette directors, however, make it perfectly clear why they are relinquishing the executive-pay
deduction: They want to preserve their independent business judgment. Changing the Boston
company's annual bonus plan "would seriously impede the compensation committee's ability to
administer the plan," the panel says in its proxy-statement report.

Under regulations drafted by the IRS, an executive's annual bonus would be exempt from the
million-dollar deduction cap if it depends on meeting objective performance tests approved by
stockholders. The Gillette bonus plan "was deliberately designed so that individual awards were
not to be dependent solely on objective or numerical criteria," the proxy notes. By deciding to do
without the tax break, Gillette's board acted "in the best interests of shareholders," says John
McGowan, a Gillette vice president. "But let's face it: the amount of the deduction lost isn't
significant." Alfred M. Zeien, Gillette's chairman and CEO, made about $1.6 million in salary
and bonus last year. Mr. McGowan estimates that forsaking the deduction on the portion over $1
million will cost the company about $233,000 this year -- a tiny addition to the $88.7 million it
paid the federal government in 1993.

Indeed, for most corporate giants, the deduction is peanuts. The minimal sums involved far
outweigh the need for directors to use their discretion, several major companies contend in their
proxies. Xerox Corp. probably will lose less than $150,000 by giving up the tax break in 1994,
says Larry Robinson, director of corporate compensation at the Stamford, Conn., concern. On the
other hand, he points out, a rigid bonus formula can "hamstring how you pay your executives" in
a rapidly changing global market.

Still, ignoring President Clinton's effort to restrain excessive executive pay -- a hoped-for result
of the new tax law -- could hurt businesses' public relations more than their tax bills. At poorly
performing companies, the forgone tax break "is going to be another thing that investors will
throw out at management," suggests Samuel Berger, a principal of accountants Price Waterhouse
in New York.

Some observers believe that could happen at Kodak, the photography and healthcare company
burdened by increased competition and slower growth in its core film business. A generous pay
package helped persuade George M. Fischer to quit the No. 1 job at Motorola and take Kodak's
helm in December. Besides a $5 million sign-on bonus, a restricted stock grant worth $1.3 million
and options to buy 1.3 million shares, Mr. Fischer gets a $2 million salary and a guaranteed
minimum bonus of $1 million this year and next.

Kodak, based in Rochester, N.Y., says it will give up the deduction on the excess portion of Mr.
Fischer's 1994 salary, at a cost of between $400,000 and $430,000. (The executive's guaranteed
bonus won't count toward the million-dollar deductibility limit until 1995, when he actually
receives this year's award.) Kodak directors could have saved the deduction by asking Mr.
Fischer to defer some pay until he leaves following the example recently set by the heads of
Weyerhaueser Co., Coastal Corp. and Sears, Roebuck & Co. "It was not a route that the
compensation committee wanted to take. They just didn't feel it was appropriate to ask him to do
that," recalls Jerry Francis, director of executive compensation.

But some institutional shareholders may reject Kodak's explanation. "It's not a good time in
Kodak's corporate life cycle to be cocky," says Gary Lyons, a vice president of Institutional
Shareholder Services Inc., a proxy-advisory concern in Bethesda, Md. (Kodak reported a 1993
loss of $1.52 billion.) In reviewing 1994 proxy statements, Mr. Lyons says he has so far
identified 37 major corporations that will do without the deduction and employ at least one senior
officer whose salary and bonus surpassed $1 million in 1993. The decision, he says, "could draw
a shareholders' lawsuit and make a very poor motivational statement to your employees."

Worries about a damaged corporate image as well as the expected issuance of final federal rules
may prompt certain holdouts to reverse course and seek the deduction in 1995. For instance,
Kodak's current position will cost the company between $800,000 and $860,000 in tax breaks
next year. "We could have a different scenario" by then, Mr. Francis predicts.

Xerox will reevaluate its stance next year, when "we think the regulations will be more specific,"
says Mr. Robinson. Other concerns are urging the IRS to loosen its performance-goal
requirements. The agency holds hearings May 9 on the proposed rules. "We are clearly in a
populist era," where tossing aside an executive-pay tax break "is a loser," warns Michael Davis,
head of the U.S. executive-compensation practice for consultants Towers Perrin in Chicago.
"Once you see where the herd is going," he adds, "it will become awfully hard to buck it."

Copyright (c) 1994, Dow Jones & Co., Inc