Investment Risk and the Tax Benefit of Deferred Compensation

Abstract

Deferred compensation is thought to generate significant tax savings compared to current compensation in certain circumstances. The standard model used to support this conclusion does not consider investment risk and therefore overstates the tax benefit of deferred compensation significantly. This paper describes three alternative, risk-neutral approaches to measuring the tax benefit of deferred compensation. Each of these approaches avoids misclassifying increases in expected value attributable to increases in investment risk as a tax preference.

Keywords: executive compensation, tax, tax policy, risk

JEL Classification: G34, H25, K31, K34