Legal Limits on Executive Compensation: What Leaders Need to Know
Executive compensation packages can reach staggering heights, but they don’t exist in a regulatory vacuum. A complex web of federal laws, tax codes, and oversight requirements governs how much companies can pay their top executives—and more importantly, how much they can deduct from their taxes. For executives navigating leadership roles, understanding these legal limits isn’t just helpful—it’s essential for making informed career decisions and avoiding costly compliance pitfalls.
The stakes are high. Companies that fail to comply with executive compensation regulations can face significant financial penalties, while executives may find themselves caught in the crossfire of regulatory scrutiny. The landscape became even more complex following the 2008 financial crisis, as lawmakers implemented stricter oversight measures designed to rein in what many viewed as excessive compensation practices.
The executive compensation attorneys at Barrett & Farahany break down the key regulations shaping executive compensation today, explore their real-world impact on compensation structures, and examine the challenges these rules create for both companies and the executives they employ.
Key Regulations Governing Executive Compensation
The Deduction Limit
At the heart of federal executive compensation regulation lies Internal Revenue Code Section 162(m), which prohibits publicly traded companies from deducting more than $1 million in annual compensation per “covered employee” for tax purposes. While executives can still receive compensation above this threshold, companies lose the tax benefit for amounts exceeding the cap.
Covered Employees
The regulation currently targets a company’s highest-paid individuals: the Chief Executive Officer (CEO), Chief Financial Officer (CFO), and the three next highest-compensated employees.
However, the American Rescue Plan Act of 2021 expanded this definition significantly. Beginning with tax years after 2026, covered employees will include the five next highest-compensated individuals, bringing the total to at least ten covered executives per company.
Exceptions and Loopholes
The Tax Cuts and Jobs Act of 2017 eliminated what had been a significant loophole in Section 162(m). Previously, companies could deduct performance-based compensation above the $1 million limit, provided it met certain criteria.
This exception allowed many companies to circumvent the cap entirely by structuring executive pay as performance bonuses. Today, that escape route no longer exists, making the $1 million limit more meaningful.
The Dodd-Frank Act: Shareholder Voice and Transparency
Say on Pay Provisions
The Dodd-Frank Act introduced mandatory “Say on Pay” votes, requiring publicly traded companies to allow shareholders an advisory vote on executive compensation packages at least every three years. While these votes are non-binding, they create public pressure and can influence board decisions about executive pay levels.
Disclosure Requirements
Beyond voting rights, Dodd-Frank imposed extensive disclosure requirements. The SEC now requires public companies to disclose the relationship between executive compensation and company financial performance. These “pay versus performance” disclosures help shareholders understand whether executive pay aligns with company results.
TARP and Government Oversight During Crises
Compensation Restrictions
When companies accept federal bailout funds — as many did during the 2008 financial crisis through the Troubled Asset Relief Program (TARP) — additional compensation restrictions kick in.
The American Recovery and Reinvestment Act of 2009 imposed specific limits on executive pay at companies receiving federal assistance, including caps on bonuses and restrictions on golden parachute payments.
Impact on Executive Compensation Practices
These regulations have fundamentally altered how companies structure executive compensation. Rather than simply offering high salaries, organizations now rely more heavily on complex compensation packages that include deferred compensation, stock options, and other forms of equity-based pay that may receive different tax treatment.
Performance-Based Pay Evolution
Although the performance-based exception to Section 162(m) no longer exists for tax purposes, companies continue to emphasize performance-linked compensation for other reasons. Shareholders and governance advocates expect executive pay to correlate with company performance, even when tax deductibility isn’t at stake.
Non-Cash Compensation Growth
The regulatory environment has accelerated the shift toward non-cash compensation. Stock options, restricted stock units, and other equity instruments enable companies to offer executives substantial value while potentially circumventing certain regulatory constraints.
Clawback Provisions
Modern executive compensation packages increasingly include clawback provisions that allow companies to recover compensation under specific circumstances, such as financial restatements or misconduct. These provisions help companies demonstrate good governance practices and may provide some regulatory protection.
Navigating the Complex Regulatory Landscape
Navigating executive compensation can be complex, especially for professionals securing leadership roles. That’s where the employment law attorneys at Barrett & Farahany come in. Based in Atlanta, Georgia, we are skilled in providing legal services tailored to ensure executives receive fair and equitable compensation. Whether negotiating contracts or reviewing severance agreements, our team is here to protect your career and financial future.
Your career is your most valuable asset. Don’t leave your executive compensation up to chance. Whether you’re negotiating terms, navigating workplace changes, or reviewing severance agreements, Barrett & Farahany’s experienced attorneys are here to protect your interests every step of the way.
Contact us today to schedule a consultation and take the first step toward securing the compensation and recognition you deserve.
