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Taxpayers are subsidizing CEO pay

April 24, 2014: 12:05 PM ET
Howard Schultz Starbucks

Howard Schultz received $236 million in performance pay in 2012-13.

It's hard not to feel a little jealous -- even outraged -- looking at the latest list of the highest paid CEOs in America. The top 12 all made over $20 million last year.

But there's another reason to get upset when CEOs make millions: Taxpayers are subsidizing some of this wealth.

Stock options are one of the biggest drivers of high CEO pay these days.

The idea is to give executives stock to incentivize them to do well -- as the company does better, the stock does better, and the pay of these head honchos rises.

Here's the catch: Stock options for CEOs of publicly traded companies can be deducted from the corporation's U.S. tax bill.

Related: The highest-paid CEOs in America

So when Starbucks (SBUX) paid its chief Howard Schultz $236 million in "performance pay" in 2012 and 2013, it received about $82 million in tax credits, according to a report released Tuesday by the left-leaning Institute for Policy Studies.

Other highlights from the report, which focused specifically on the restaurant industry, include:

  • Chipotle (CMG) gave out close to $200 million in performance pay to its CEO in 2012-13, generating $69 million in tax breaks.
  • The head of Taco Bell, KFC and Pizza Hut owner Yum! Brands (YUM) received $67 million in stock options in the past two years, which translated to a $23 million tax bill discount.
  • McDonald's (MCD) handed out over $34 million in CEO stock options in the last two years, for a taxpayer subsidy of just over $12 million.

The "performance pay" trend took off after Congress changed the tax rules in 1993 to allow publicly traded companies to deduct an unlimited amount of executive stock option pay from their tax bills. Many corporations responded by increasing this kind of compensation, especially as the market roared in the late 1990s.

"CEO pay growth was very dramatic during the tech boom. It's all about options in the U.S. The reason it didn't happen in other countries is that option compensation was not available or illegal," says Kelly Shue, an assistant professor at the University of Chicago Booth School of Business who studies executive compensation.

While the public is often astonished at CEO pay levels, especially compared to what an average worker at the company earns, companies argue that performance pay is much better than simply handing out large base salaries. The stock options are akin to a bonus, and they could be worth a lot less if the stock goes down.

"Executive compensation at Starbucks is linked directly to company performance," notes company spokesman Jim Olson. "In the six years since Howard [Schultz] returned to Starbucks since the height of the financial crisis, our stock has grown more than 900%. Our market cap has gone from $5 billion to about $57 billion."

Chipotle, Yum and McDonald's did not comment for this article, but the National Restaurant Association, the umbrella organization for fast food and other restaurant chains, called the Institute for Policy Studies report a "mischaracterization" of the industry and notes that it fails to highlight all the opportunities available for restaurant workers.

Starbucks, for example, offers full and part-time workers health care plans and 401(k) retirement options.

"We have a legacy of putting our partners – how we refer to our employees – putting them first," says Olson.

Stock options have come under increasing scrutiny since the Dodd-Frank Act has required greater disclosure of CEO pay to shareholders and the public. The law went a step further with a "say on pay" provision to allow shareholders to have some oversight of executive pay.

Related: 4 ways to defend executive pay under the say on pay law

Shareholders of Oracle (ORCL), for example, have voted against the pay package for CEO Larry Ellison twice. Ellison often tops America's highest paid CEO list.

The problem is the shareholder vote is non-binding, so the vote is a mere public rebuke, which only goes so far. Shareholders would have to vote to change the company's board members if they really wanted to have an impact on CEO pay since boards have the final authority on executive compensation.

In Washington, there's increasing political will to take action on performance pay.

Congressman Dave Camp (R-Michigan) who chairs the House Ways and Means Committee, has put forward a comprehensive tax reform plan that would repeal the tax deduction for CEO performance pay.

Related: How to tame skyrocketing CEO pay

According to a summary of the proposed tax change by the Ways and Means Committee, some lawmakers are concerned that executives could "manipulate quarterly results" to boost their stock option compensation instead of focusing on "the long term success of the company."

Repealing the performance pay deduction rule would increase U.S. tax revenues by $12.1 billion over the next decade, according to estimates from Congress' Joint Committee on Taxation.

That wouldn't go very far toward narrowing America's deficit, but it would be one less taxpayer giveaway to big corporations.

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Heather Long
Heather Long
Markets & Investing Editor, CNNMoney

Heather Long is markets and investing editor for CNNMoney. She was formerly an assistant editor at The Guardian and an editor at The Patriot-News, which won the 2012 Pulitzer Prize for Local Reporting. She started her career at the investment consulting firm Cambridge Associates and is a Rhodes Scholar. Follow her on Twitter @byHeatherLong

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