Loans to Executives
Have Companies Lost a Valuable Tool?
Over the past decade, loan programs had become a mainstay in executive compensation. Companies granted loans to executives for multiple reasons, including but not limited to: sign-on bonuses, stock purchases, relocation, home purchases, etc. Many of these loans were granted with the expectation that the executive would fulfill the commitment and repay the loan. With fierce competition for labor and an increasingly mobile workforce, many companies instituted programs to forgive the outstanding loans over a period of time in exchange for the executive's continued employment.
The premise of loan forgiveness is not inherently bad, especially when used as a sign-on mechanism in the place of a straight cash bonus. However, a few companies abused the practice and offered executives multi-million dollar loan forgiveness packages. Set in the context of the recent corporate scandals, the practice appeared to be just another deception to shareholders. In response, Congress added Section 402 (the "Section") to the Sarbanes-Oxley Act of 2002 (the "Act"), which prohibits personal loans to executives and directors of public companies. The only exception is for companies whereby the loan is made in the ordinary course of the consumer credit business of the issuer. Such type of loan is one made available to the public with terms that are no more favorable than those offered by the issuer to the general public for such extension of credit. Loans currently outstanding will be "grandfathered"; however, no modifications to the loan may be made after the effective date of the law.
Due to the infancy of the Act, it is still unclear what the actual consequences of the Section will be. However, because a majority of the loans were granted as sign-on bonuses or for stock purchases to fulfill stock ownership requirements, it can be expected that companies will revert to the practice of paying cash sign-on bonuses and forego executive stock ownership requirements. Thus, further damaging the executive's link to shareholders.