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Tax Law

C-Suite Scholarship

Professor David Walker’s research and writing focuses on executive pay and taxation, including a recent piece on compensation clawbacks.

But, despite the high-profile nature of executive pay clawbacks and the vast sums of money at stake—McDonald’s is currently seeking $37 million in severance it paid to a former chief executive who had affairs with subordinates—no one seems to have considered how taxation related to clawbacks should be handled: Should executives whose pay is rescinded be able to, in turn, recoup the taxes they previously paid on that compensation?

That’s the question Boston University School of Law Professor David I. Walker set out to explore in “Executive Pay Clawbacks and Their Taxation,” a forthcoming Florida Tax Review article.

For Walker, the intersection of executive pay and tax is fascinating and fruitful, providing never-ending fodder for scholarship with real-world implications. Before joining the faculty, Walker worked in the tax department at Ropes & Gray, where he handled everything from mergers and acquisitions to charitable giving and specialized in the taxation of executive compensation plans. In addition to clawbacks, his recent scholarship includes a Washington & Lee Law Review article examining the rationale behind deferred compensation plans and a Boston University Law Review piece debunking the theory that the increase in large, institutional investors owning broad swaths of the economy—including shares in competing companies—has led to less competitive executive pay practices.

For the clawback piece, Walker’s goal was simple: “I wanted to understand how the tax rules would affect” the practice by which companies recover executive compensation, he says.

He also wanted to get ahead of potential regulations in the area. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the US Securities and Exchange Commission (SEC) is supposed to finalize a rule requiring compensation recovery policies at publicly traded companies. So far, the agency hasn’t acted, but by some accounts over 90 percent of the largest publicly traded companies have voluntarily adopted clawback policies.

It turns out—perhaps not surprisingly—that the relationship between taxes and clawbacks is, as the New York Times DealBook column noted when it succinctly summed up Walker’s article, “really complicated.”

Basically, Walker says, the situation depends. “One executive might have no tax penalty because they had deferred compensation, and another may end up with a big tax penalty.”

But the issue is worth exploring. As Walker explains in his paper, up to 50 percent of executive pay goes to the government in taxes.

“That’s a huge portion,” he says. “I don’t think people realize how much is at stake in the tax treatment of clawbacks.”

Walker argues that executives should be able to recover the taxes they paid on compensation later clawed back. That idea aligns with the general principle that tax rules should be neutral; people should neither be penalized nor given an advantage for following them (exceptions are so-called Pigovian taxes—such as taxes on cigarettes or sugary sodas—that seek to deter some behavior detrimental to society as a whole).

“I’m in favor of rigorous clawback rules,” Walker says. “It’s never made sense to me that executives could hold onto money that wasn’t earned. But, if we are going to have government-enforced clawbacks, I want them to be implemented honestly and accurately.”

Walker says allowing recovery of taxes also increases the likelihood that executives will comply with clawback proceedings.

“If tax treatment is neutral, if it’s viewed as being fair, you get better compliance,” he says.

Walker says existing tax laws should be interpreted liberally to allow executives to recover previously paid taxes because the likelihood of passing new laws to benefit highly paid executives—especially those accused of wrongdoing—is probably politically unpalatable (as Walker writes in the paper, the idea has “particularly poor optics” even though it “simply restores the status quo ante.”)

After more than two decades exploring corporate governance through the lens of executive pay and taxation, Walker says “pay practices are getting better,” including through the use of relative performance evaluation that takes into an account how a company is doing compared to its peers, improved board oversight, and tax and accounting rules, which Walker focuses on in his own scholarship.

“I’m not convinced that we aren’t still overpaying executives—my guess is they’re getting more than they would if the market worked perfectly,” he says. “But the ways we’re paying them have gotten better.”