There’s not much evidence that the income boost to the average American household from cutting corporate taxes last December, “very conservatively” estimated at $4,000 by the White House’s economics team, has been materializing.
To be fair, this was a longer-term idea, related to better after-tax returns on capital and thus greater capital investment.
Top executives, though, are one group of workers that already has done just fine thanks to corporate tax cuts. And it is not so much what they are getting paid this year but what they have kept from all the previous years.
The details of executive compensation are found in corporate proxy statements, and they all sound alike. Big companies all say they are eager to pay for performance and tie executive pay to long-term shareholder returns.
At least a little skepticism seems fair for how companies really pay “workers” tens of millions of dollars, yet it’s hard to imagine directors dropping a bonus on a CEO for increased profitability when all that happened is their federal government just cut the tax rate to 21 percent.
A lot of big companies did not pay the old 35 percent statutory rate, of course, yet domestic companies like retailers, banks and insurers could not as easily lower their tax bills. They couldn’t easily claim a research-and-development tax credit or keep profits stashed in an Irish subsidiary.
They had reason to gripe. The S&P 500 average tax expense percentage was in the mid-20s, and Target Corp.’s effective tax rate has lately been around 32 to 33 percent. UnitedHealth Group’s tax expense even exceeded 42 percent of pretax income as recently as 2015.
The tax cut is making a big impact on the reported financial results of companies like that, as you would expect. UnitedHealth just reported that earnings from operations, a pretax measure, increased 13 percent in its second quarter, while after-tax earnings per share jumped by 28 percent.
Lower tax expense is one big reason the after-tax number grew so much, as UnitedHealth booked income tax expense at a rate of just 22 percent in the June quarter, almost 10 percentage points under what it recorded in the same period last year.
You would think that nobody has gained more from tax reform than officers of companies like that. It’s not clear, though, that a lower tax rate increased the reported pay of these executives at all. A good case in point is Target.
What pops up right away in Target’s proxy statement is how the board uses after-tax return on invested capital as a measure when awarding stock-based pay. To state the obvious, after-tax returns increase with lower taxes.
What matters to Target isn’t the actual returns, though, but whether the company’s returns on invested capital were better than they were for a basket of 18 peer-group companies. All 18 of those companies received the same tax cut in December, too, and the same artificial boost in after-tax returns. There’s no advantage to anyone working in the C-suite at Target.
Another form of stock-based pay is handed out for total return to shareholders, a simpler calculation but also one that’s based on how well the company did compared to its peers.
UnitedHealth’s board approaches its stock-based pay differently, awarding stock-based pay for reaching targets of cumulative earnings per share and a return on shareholder equity over a three-year period.
The proxy describes how cumulative EPS exceeded the board’s target, while return on equity for the 2015 through 2017 performance period came up just short. Unfortunately, the proxy said little about where these key targets have been set for this year and beyond. You hope that whatever the targets were, the board went behind closed doors and revised them upward after the tax act was signed.
One hint of how this board might think comes from last year’s results. After assessing the tax bill’s impact on the balance sheet, UnitedHealth saw a $1.2 billion bump in earnings. Management had nothing to do with that, so the board ruled that gain out of bounds when calculating pay.
Just one more thing is worth considering, and it’s not spelled out in the proxies. What has happened to all the stock senior executives collected in the past for coming to work? There’s no denying that the tax cut has boosted share prices.
About the time the tax-cut legislation was signed last December, the consensus view for the S&P 500 was that earnings per share would increase in 2018 by about 11.4 percent, according to investment strategist Sam Stovall of New York-based research firm CFRA. The estimate of EPS growth has since grown to 21 percent, although he cautioned that the tax cut isn’t the only reason.
Bigger benefit in 2017
So far this year, the S&P 500 is up only about 5 percent, meaning that by the important measure of stock market value, the “multiple” of this year’s estimated earnings, the stock market is lower priced than it was back in December.
“A lot of the benefit of the tax cut was already reflected in 2017 share prices,” Stovall said. “We had a 20 percent gain in share prices in 2017, quite a bit stronger than what was anticipated by the Wall Street consensus. The tax cut served as a carrot for investors to move forward in this bull market and allowed share prices to rise.”
That means that those best positioned, as corporate taxes were slashed, were not up-and-comers but esteemed statesmen on the way out — someone like Stephen Hemsley, who stepped down as CEO last year at UnitedHealth.
As of the last proxy, Hemsley owned 3.9 million shares of UnitedHealth stock, including shares from equity pay programs that would soon vest. UnitedHealth shares have surged about 60 percent since the start of 2017. It only takes a one-cent uptick in the price of 3.9 million shares of stock to about match the $4,000 increase in wages for 10 average families put together — if that $4,000 wage increase ever shows up.
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