Deferred compensation: does it work?

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deferred compensation, baseball, Bobby BonillaFormer Major League All-Star Bobby Bonilla made headlines on July 1st, 2011, when he showed up on the New York Mets payroll. Most would expect a 48 year old former major leaguer to be on the payroll in the position of a coach or mentor, but Bobby Bonilla was just beginning to receive money that he chose to defer 11 years prior while he was still an everyday baseball player. The decision turned out to be a wise one. July 1st, 2011 marked the first day that Bonilla would be receiving payments all the way until July 1st, 2035.The $5.9 million that he and the Mets agreed to defer with an 8% annual interest back in 2000, will turn into $29.8 million by the time he has received each of his annual payments. Turning $5.9 million into $29.8 million gets the headlines for obvious reasons, but when do situations like this come up in everyday life and why do companies employ deferred compensation?

The Mets decided on this move at the time so that they could immediately free up some money to improve the team in the hopes of a playoff run. When it comes to regular companies, deferred compensation is often used in the way of performance rewards for senior management and key employees when the company is excelling. In these instances, the company is banking that these employees will bring current benefits to the company, with no current cash outflows, but will be rewarded on the back end. However, for financial reporting purposes, companies will still be required to record deferred compensation by recording an expense and associated liability during the service period that is required for the employee to vest in the deferred compensation (i.e. as services are performed). The employee can delay recognizing income for tax purposes on this since they don’t receive any compensation payments, but will start recognizing income in later years once that cash is received. Deferred compensation can be a decision that comes with some risks though. The Mets weren’t worried about the extra money they would have to pay Bonilla in the future because of the stellar returns they were getting on their investments in Bernard L. Madoff Investment Securities, which they eventually found out was one of the most elaborate Ponzi schemes ever and resulted in the Mets losing about $170 million. The Mets were one of many victims of the scheme and shouldn’t be knocked on their decision to defer compensation. In everyday practice, payments of deferred compensation can be an additional cash flow drain during a period where there is no correlated employee service to the company. Everything comes with some amount of risk and deferred compensation plans and agreements will continue to be used as part of a compensation package as companies will do what they have to do to keep their most productive and performance-increasing employees happy.

CJ McGrady