Tuesday, February 16, 2010

Ed Clark pays tax at the rate of 23% on 80% of his income

Rather than invoking Canadians to make his argument that "The Canadian population is extremely unhappy to see these deficits," and that raising Canadians’ taxes is the answer, I think Ed Clark, CEO of TD Bank, should lead by example. That’s because Ed Clark and all his fellow members of the CCCE who profess to speak on Canadians’ behalf are the beneficiaries of a grossly unfair and highly outdated tax policy that was borne out of the Tech Bubble, namely the tax treatment of gains from executive stock options at half the rate of taxation that is applicable to the income from employment (which they are), and treating them as if they were gains from capital being at risk (which they are not), and taxed at half the normal rate of 23%, instead of 46%.

And who was the champion who ushered in this grossly unfair tax treatment of executive stock options during the Tech Bubble on the premise that it would be the cure all to Canada’s supposed “brain drain” at the time? None other than John Roth, CEO of now bankrupt Nortel. The same Nortel whose employees’ pensions are now at risk of default and are being bailed out at the tune of some $200 million by taxpayers in Ontario. Meanwhile John Roth lives in his world of luxury, subsidized by Canadian taxpayers, in both the first instance and now the second instance.

The idea that the risk free gains from Executive Stock Options are being taxed at half the rate of income from employment that they represent and subsidized by all other taxpayers is an absurdity. An absurdity made even more profound and obvious when it is understood that these very executive stock options and the culture of corporate behaviour that they induce is at the very heart of the Global Financial Meltdown, as logic would tell you, and as Roger Martin, Dean of the Rotman School of Management has written about in pieces like “Distorted incentives behind the financial crisis”, see below.

Why do you think Ed Clark was a major proponent bank mergers? Because it was good for Canada, which it clearly was not, or because it maximized his stock option gains? Just ask Roger Martin if that answer concerning distorted incentives isn’t obvious to you.

Why do you think Michael Sabia conspired with Jim Flaherty to kill income trusts? Because it was good for Canada or BCE shareholders, which it clearly was not, or because he thought the private equity alternative that he favoured would maximize his stock option gains? Just ask Roger Martin if that answer concerning distorted incentives isn’t obvious to you.

Why do you think Manulife's CEO decided to not hedge any of the the risks in the variable rate annuity products like Income Plus? Because it was good fro Canada or Manulife shareholders, which it clearly was not, or because it maximized his stock option gains? Just ask Roger Martin if that answer concerning distorted incentives isn’t obvious to you.

So what does this have to do with Ed Clark’s views on paying down the deficit? Plenty, as the much needed policy change of treating executive stock option gains like the income from employment that they represent, rather than as capital gains which they are not, we will achieve two important goals. Ed Clark’s professed goal of all Canadians wanting to pay down the deficit by raising taxes (presumably that includes him?) and my goal and the goal of Roger Martin of removing a system of distorted incentives like stock options from the equation. While it may be a bit heavy handed for Ottawa to outlaw the idea of executive stock options at large, as thing presently exist all taxpayers are subsidizing that roulette wheel by granting people like Ed Clark with an unjustified tax treatment of executive stock options, in which 80% of his income is being taxed at the rate of 23%, or what a person earning $36.848 a year, and struggling to make ends meet pays, and serving the policy outcome of distorting incentives.

Based on TD Bank’s December 4, 2009 40F filing with the SEC for the year ended October 31, 2009, the following executive stock options were outstanding

Beginning of the year: 27.5 million with exercise price of $55.37
Exercised during the year: 4.6 million with exercise price of $39.26
Granted during the year: 4.0 million with exercise price of $41.50
Cancelled: 1.0 million
End of the year: 25.9 million with exercise price of $53.25, of which 21.1 million are in the money at today’s stock price, resulting in an exercise price of $48.75
Held by Ed Clark: 2.3 million or roughly 9% of all outstanding options.

Therefore with the price of TD Bank’s share at $65.50, these stock options have an embedded gain of $353 million, which will be taxed at 23% rate of taxation rather than a 46% rate of taxation, meaning that all Canadian taxpayers are subsidizing these TD Bank executives to the tune of $81 million. This is only one bank. There are five others, and countless other public companies whose executives are being taxed on terms that are grossly unfair to all other taxpayers. The foregone tax revenue would surely be in the billions. Meanwhile these are the very same corporations who are getting $2 billion a year in annual windfall profits from the HST and its arbitrary reduction in corporate taxes, that will only serve to generate more ill gotten stock option gains

Meanwhile these banks like TD Bank have extremely generous pension plans that are rewarding these very same executives with pensions that have a value today of $1.9 billion plus non pension post retirement benefits equal in value to another $329 million, and in the case of Ed Clark, will pay him at the annual rate of over $1 million a year.

Meanwhile, with all of these riches at their feet, the TD Bank and Ed Clark specifically is calling for average Canadians like former TD Bank client David Marshall, a retired truck driver from Cornwall Ontario, to incur double taxation on his retirement income at levels as high as 65%, while Ed Clark’s retirement income is only taxed at 46% and 80% of his employment income is taxes at 23%?

This is an absurdity and a disgrace for Ed Clark to be telling former TD clients like David Marshall that they should accept Stephen Harper’s lies about tax leakage and rejoice in the world of certainty that Ed Clark favours, in which Ed Clark gets taxes at 37% of the rate of income that retired truck driver, David Marshall does (23% versus 62%) and be acceptant of that, as Ed Clark’s and Stephen Harper’s idea of a Tax Fairness Plan.

It’s no wonder that David Marshall quit the TD Bank as a former disgusted TD Bank client. I only wonder whether Michael Ignatieff will be so quick to come to the rescue of David Marshall and the other 2.5 million Canadians who were abused by Harper income trust “vandalism” (as Ignatieff calls it) and embrace the win win solution known as the Marshall Savings Plan, to bring some true tax fairness to the table on behalf of the Council of Common Canadians (CCC) rather that Ed Clark’s CCCE?

Distorted incentives behind the financial crisis

The concept of 'shareholder value' has run beyond its limits, business school dean Roger Martin says
Globe and Mail
May 22, 2009

Kerry Stirton is a New York-based investment manager, formerly of Goldman Sachs. Each week Mr. Stirton examines a facet of the current economic situation.

Events of the past year have thrown up no shortage of theories about the causes of the financial crisis but an alluring new entry picking up steam comes from Roger Martin, dean of the Rotman School of Management at the University of Toronto.

In his view, a skewed theory about management incentives - paying for share price increases over any other measurement - was a major factor in distorting the corporate world. If it had not become so widely held, and taken to such extremes, the crisis might have been averted.

He makes his case in the following interview:

You haven't been afraid of disturbing the status quo, and have advanced the Rotman School in some audacious ways. But how does this latest foray into the excesses of shareholder value theory, and its role in the financial crisis, fit into the overall thrust of what you are leading at Rotman?

There is an answer to that. Our Centre for Integrative Thinking focuses on the study of how CEOs and other business people, investors included, make decisions. The financial crisis was caused by a broad range of executive decisions.

People may think they are just making decisions on the basis of some interest or perceived interest in the moment, but they are usually governed by a background theory.

In this case, I've been trying to unwind the crisis through an explanation of the distorted theories that formed the basis of a lot of stupid corporate and investment decision-making on the part of so many people who are actually not at all stupid. So it relates to that fascination. We are reverse engineering the decision-making processes. How could they have made so many bad decisions, causing the cataclysm we've been enduring?

What is your conclusion?

Unfortunately, the well-regarded and deeply entrenched theory of "shareholder value" - in which it is believed that the main job of executives is to maximize the share prices of the companies they run - was permitted to extend far past its appropriate boundaries. Practically speaking, the theory originated in the 1970s, by Jensen and Meckling, and it sought to reconcile the potential misalignment of interests between company shareholders and company managements. It did so by constructing packages of stock and stock options packages that would guide executive compensation. But it got completely out of control.

Through a kind of kitchen logic, executives of all sorts of companies, and especially some financial companies, started forgetting about what the real purpose of their company was, and they allowed only stock price considerations to drive their incentives and hence their conduct. That undermined the entire system.

Can you elaborate? It surely can't be the case that company managements focused only on their stock prices?

The empirical basis of the case is very strong. If you examine U.S. compensation patterns since the 1960s, and look at the ratio of how much net income a company generates relative to the annual compensation of its top executive, you will see that between the 1976 Jensen-Meckling paper, and the early 2000s, the amount of compensation earned by CEOs, relative to the real value they created, grew by more than 600 per cent.

Some of this growth was perhaps a function of companies having done better substantively, but the stock market's increase in value was caused, in sizable part, by executives who were being more frequently, and in larger magnitudes, incentivized to drive their stock prices up - whether their companies' cash flows rose commensurately or not.

You don't think the recent collapse of the financial system had more to do with financial institution excesses than regular corporate practices and compensation systems?

Both of those groups' incentive systems were polluted and ultimately caused the crash. Think about it by analogy to a hockey team.

In the NHL, a real game of hockey is played, and at the end of it, there have been some goals scored and allowed, with a clear winner and a clear loser. The players ultimately get compensated on the basis of how well they contribute, and their play can be broken down into clear statistical outcomes. This is the real game.

Associated with that, you have a betting market which deals in expectations. You know: "I will take the Penguins over the Hurricanes by one goal". But whatever the outcome in the expectations game, the players are still incentivized to play well in the real game. They can't distort or exaggerate their performance. It is what it is.

Likewise, in business and the capital markets, you have a real market - what the company's cash flow is, how many cars it produced in a year - and you have an expectations market, represented by stock prices in the stock market.

But that's where the hockey analogy breaks down. Because the shareholder value theory has caused compensation consultants, boards, and CEOs to push managers' stock-based compensation to such ridiculous heights, the managers now have huge personal incentives to tell expectations-raising stories, for the "benefit" of the stock.

But they simply can't keep expectations rising forever. Expectations are inherently cyclical. They have never been otherwise.

But don't you think the financial market had more distortions built into it? Isn't it easier to tell a story about the value of your securities' book and real estate holdings than how many airplanes you sold?

Yes. The financial market players' incentives became even more dramatically unhinged. In the world where proprietary trading and investing became a much bigger part of their profit equation, something that used to temper a company's zeal for its stock became untethered.

Think of a company like Procter & Gamble. Its real game is to make the lives of consumers a little better every day. It cares about shareholder value, incentive alignment and its stock price as well, but it knows it needs to keep the service mission in place.

Contrast that with Wall Street, where the only value in play seems to be how to profit from stock prices (or bond prices). The goal of making a higher quality product for a real consumer got pushed way into the background.

So how do we unravel ourselves and get back to a position of balance, where the virtue of shareholder alignment can be enjoyed without the excesses?

It won't be easy. The kitchen logic version of the theory is still thoroughly entrenched. People are just talking about how to "tweak" stock incentive plans. But they need to get rid of them. And at Rotman, we're doing our part to put things in perspective. Hopefully others will get on board soon. The real market is where it's at. We have to return to the real game, as soon as we possibly can.


Dr Mike said...

It`s obvious to us victims that Ed Clark is the winner & the rest of us are the losers.

He is already a millionaire & we are just scratching to make enough income monthly to get by.

We get squashed & he gets a leg up.

So what gives here??

I guess having the bent ear of the Finance Minister in your pocket is better than scraping every day to get by.

Thanks to everyone on the Hill (who we have hired to look after our best interests) , we are going down with the sinking ship that they sabotaged.

Geeez , I hate these guys.

Dr Mike Popovich

Anonymous said...

Interesting interview the dean of Rotman.

Is there anything recent from Mr. Schulich or anything like this from Dean Horvath at York U? Perhaps both of them have commented on the Marshall Savings Plan?