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In part one of this series (Tales of Cobras, Windows, and Economic Promise), I discussed the “cobra effect.” It is a term that derives from a venomous cobra outbreak in India. I chose this tale to exemplify how solutions to problems, on occasion, have the opposite of the intended effect.

In this article, I present a two-headed cobra effect: Government legislation designed to limit executive compensation runs afoul of economists and academia who chose to base executive compensation on “performance.”

Bush versus Clinton

In the early 1990s, like today, there was a disproportionate gap between corporate executive and employee compensation. Academia held the belief that the level of executive compensation was not warranted based on executive performance, claiming that closing the gap would benefit employees and the economy.

In 1992, there was a presidential election between George Bush, the sitting president, and the two-term governor from Arkansas, Bill Clinton. Part of Clinton’s campaign pledge was to tame what he called, “excessive executive pay.”

Specifically, Clinton intended to reverse a recent veto by President George Bush, limiting corporate tax deductions for executive compensation.

After being elected in November of 1992, Clinton signed into law section 162(m) of the IRS code. The code limits corporate deductibility of executive pay to $1 million for “named executives” at publically traded companies.

Financially penalizing companies with high wage-earning executives may seem like a smart way to limit compensation. Then again, putting a bounty on cobra heads also seems like a reasonable way to get rid of cobras.