Tax Incentives for Inefficient Executive Pay and Reward for Luck
Robert F. Göx
University of Zurich - Department of Business Administration (IBW); University of Zurich; University of Zurich - Faculty of Economics, Business Administration and Information Technology
I study the economic consequences of tax deductibility limits on salaries for the design of incentive contracts. The analysis is based on a simple agency model in which the firm's cash flow is a function of the agent's effort and an observable random factor beyond the agent's control. According to my analysis, limiting the tax deductibility of fixed wages has two consequences. The principal rewards the agent on the basis of the observable random factor and offers him a contract with weaker work incentives than without the tax. The theoretical findings have some interesting implications for empirical compensation research. First, the analysis shows that reward for luck can be the optimal response to recent tax law changes, whereas earlier empirical literature has attributed this phenomenon to managerial entrenchment. Second, I demonstrate that a simple regression analysis that fails to control for separable measures of luck is likely to find an increased pay for performance sensitivity as a response to the introduction of tax deductibility limits on salaries although the pay for performance sensitivity has actually declined.
Number of Pages in PDF File: 51
Keywords: Executive Compensation, Reward for Luck, Performance-based pay, Agency Model, Taxes
JEL Classification: D82, C51, C81, J31, J33, K34, M52working papers series
Date posted: October 18, 2005 ; Last revised: March 12, 2008
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo6 in 0.375 seconds