Incentive Effects of Bonus Taxes in a Principal-Agent Model
University of Zurich Institute for Strategy and Business Economics Working Paper No. 140
29 Pages Posted: 12 Dec 2010 Last revised: 17 Aug 2012
Date Written: December 11, 2010
Several countries have implemented bonus taxes for corporate executives in response to the financial crisis of 2007-2010. Using a principal-agent model, this paper investigates the incentive effects of bonus taxes by analyzing the agent's and principal's behavior. Specifically, we show how bonus taxes affect the agent's incentives to exert effort and the principal's decision regarding the composition of the compensation package (fixed salary and bonus rate). We find that, surprisingly, a bonus tax can increase the bonus rate and decrease the fixed salary. In addition, a bonus tax can induce the principal to pay higher bonuses even though the agent's effort always decreases.
Keywords: Principal-agent model, bonus tax, executive compensation, incentive, pay regulation
JEL Classification: H24, J30, M52
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