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News from EPI Limiting corporate tax deductibility won’t stop spiraling CEO pay

The disclosure of publicly traded companies’ CEO-to-average-worker pay, a requirement of Dodd-Frank, is shining a spotlight on the rapid increase of executive compensation and how it drives income inequality. The Center for Economic and Policy Research (CEPR) and Economic Policy Institute (EPI) used a provision in the Affordable Care Act (ACA) to test whether CEO pay closely corresponds to their value to the company. The findings, published today in, Does tax deductibility affect CEO pay? The case of the health insurance industry, by CEPR senior economist Dean Baker and EPI research assistant Jessica Schieder, found little evidence of a link between CEO pay and the value of a CEO to the company. Instead, argue Barker and Schieder, skyrocketing CEO pay is largely the result of a broken corporate governance system.

Schieder and Baker examined an ACA provision that went into effect in 2013 which prevents health insurers from deducting CEO pay over $500,000 and taxes any pay over the cap as profit. This effectively raised the cost of CEO pay to insurers by more than 50 percent. If pay were closely related to the CEO’s value to the company, then the result would be a decline in the pay of health insurance CEOs, relative to other CEOs, to bring their pay back in line with the cost to the company.

When controlling for performance factors, like the increase in stock returns and rise in profits, the study found no evidence of a decline in the pay of CEOs at insurers, relative to other CEOs. This suggests that high CEO pay is due to a broken corporate governance system. Furthermore, CEO pay will not be slowed by the extension of the corporate tax deductibility mechanism under the Tax Cuts and Jobs Act.

“Our results find zero evidence of a decrease in the pay of insurance company CEOs,” said co-author Baker. “That suggests that pay is not closely related to the CEO’s value to a company. It also means that if we want to see a reduction in CEO pay, we will have to fix a broken corporate governance structure.”

Schieder and Baker posit that spiraling CEO pay is the result of the breakdown of a corporate governance system that held down CEO pay in the decades immediately following World War II.

“To rein in CEO pay,” said Schieder, “transform corporate structures that allow CEOs to set their own pay by placing friends on boards of directors that have oversight.”