Why are Canadians Subsidizing Executive Stock Options?
It’s time to axe an executive tax break that encourages perverse behaviour while enriching the very rich.
If you’re a top executive at a major corporation, no need to read further; you’ll know all this.
But if you’re an ordinary person, you may not. You’ve probably heard of “executive stock options” — a perk that allows corporate executives a special deal on purchasing the company’s stocks.
And you may suspect that these stock options are connected to the rampant greed and corruption that have plagued the corporate world in recent years. If so, you’d be right.
Even leading business thinkers agree.
Writing in the Wall Street Journal, the renowned business scholar at McGill University Henry Mintzberg argued that executive stock options “represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy.”
Canada compounds the problem by adding a special tax break that makes executive stock options even more lucrative — and costly to the Canadian treasury.
So when Opposition leader Tom Mulcair announced earlier this year that an NDP government would scrap the tax break entirely, nobody rushed to its defence. It turns out that this tax break — so beloved by the business set which lobbied heavily for it — is barely able to round up a friend outside the boardroom.
Mulcair promised to direct the revenue savings — possibly hundreds of millions of dollars a year — to the poor.
Even among tax breaks, the one for executive stock options is particularly outrageous. Yet, as pre-election controversy swirls around income-splitting and Stephen Harper’s other tax breaks favouring high-income earners, this — the gorilla of all tax breaks — remains largely out of sight.
It’s hard to think of another tax break that benefits so few people so much — and for no good reason.
For instance, 75 of Canada’s 100 top-paid CEOs held executive stock options in 2013. Economist Hugh Mackenzie has shown that the total value of their tax savings amounts to $495 million, or an average tax saving of $6.6 million each.
In other words, Canadians are providing a tax subsidy worth almost half a billion dollars — to just 75 individuals, who are already very rich.
Executive stock options allow companies to reward their senior managers by letting them buy company stock at a point in the future — at today’s price.
So, if the stock is worth $10 a share today, the executive can exercise her option in the future, paying only $10 a share for stocks that have risen to $15, $20 or even $50 a share — a fantastic deal.
And in Canada this windfall is only taxed at half the rate of regular income. (The U.S. offers no tax break for executive stock options.)
There’s no risk for the executive; if the stock falls in value, she’s under no obligation to exercise her option.
This makes the option like “getting to bet on a horse race after the race has been run,” notes Calvin Johnson, a tax professor at the University of Texas Law School.
The option also creates perverse incentives, encouraging executives to try to artificially push up the company’s stock price in the short-term so they can cash in. This entices them to take risks with the company’s assets, use accounting trickery and otherwise behave in ways that are at cross-purposes with the best long-term interests of the company, its shareholders and its workers.
Johnson says stock options encourage executives “to undertake risks that are suicidal for the company as a whole.”
Among the accounting trickery is the practice of “back-dating” the option to when the stock was particularly low in value, allowing executives to score especially big gains. Earlier this month, Penn West Petroleum, a Canadian oil and gas company, acknowledged backdating options in a case currently before the courts.
Stock options figured prominently in the enormous windfall scored by the once-celebrated former Nortel CEO John Roth.
Roth, who scolded Canada for not offering bigger tax rewards for corporate superstars like himself, cashed in his stock options in 2000 for a personal gain of $135 million — all taxed at the special low rate — shortly before the company’s spectacular collapse left investors with heavy losses and thousands of Nortel employees out of work.
Given their tendency to encourage perverse behaviour while enriching the very rich, it’s time we stopped subsidizing executive stock options through the tax system. The overindulged corporate set surely doesn’t need additional financial help out of the pockets of ordinary, hard-working Canadians.
© 2015 The Toronto Star