The Puzzle of Non-Qualified Retirement Pay

Abstract

Pay arrangements for managers of public corporations typically include substantial amounts of compensation deferred through non-qualified retirement plans. As a departure from the familiar baseline of current payment for current services, this presents a longstanding puzzle. The corporate-governance literature offers two explanations for the practice. The “optimal-contracting account” argues that non-qualified retirement pay represents “inside debt” that aligns the interests of managers with the interests of the corporation’s unsecured general creditors. The “managerial-power account” argues that non-qualified retirement pay represents “stealth compensation” that facilitates the extraction of rents from corporate assets. In this paper, I set out a different explanation based on tax considerations. Specifically, I argue that corporations and managers use non-qualified retirement pay to substitute lower corporate tax rates for higher individual tax rates on investment income, to avoid the $1 million limitation on corporate compensation deductions, and to avoid state income taxes. The tax account is at least as strong as the other two accounts in explaining the motivation for the basic decision to defer manager compensation and is superior to the other two accounts in explaining the contractual terms of non-qualified retirement plans.

Keywords: Executive compensation, manager compensation, non-qualified retirement pay, deferred compensation, executive pensions, optimal contracting, inside debt, managerial power, rent extraction, stealth compensation, tax policy, taxes

JEL Classification: G30, G34, J33, K34