Management Incentives Under Formula Apportionment – Tax-Induced Distortions of Effort and Compensation in a Principal-Agent Setting

Arqus Quantitative Tax Research Discussion Paper No. 168

54 Pages Posted: 11 Jul 2014

See all articles by Jan Thomas Martini

Jan Thomas Martini

Bielefeld University - Department of Business Administration and Economics

Rainer Niemann

University of Graz, Center for Accounting Research; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Dirk Simons

University of Mannheim - Accounting and Taxation

Multiple version iconThere are 2 versions of this paper

Date Written: July 10, 2014

Abstract

The introduction of a common consolidated corporate tax base (CCCTB) and tax allocation via formula apportionment (FA) is hotly debated in the European Union (EU) since more than a decade. While the literature has thoroughly analyzed the economic effects of FA from a macro-level perspective, the firm view has been added only recently. Within this micro-level framework discussing possible tax-induced distortions of multi-jurisdictional entities’ (MJE) decisions becomes feasible. Anticipating the reactions of MJEs to the introduction of FA requires considering delegation and incentivisation, because management decisions are influenced by principal agent relationships.

How FA affects the demand for managerial effort is a hitherto neglected research question. Accordingly, the objective of this paper is to highlight the tax-induced distortions of managerial incentives caused by FA. For this purpose we set up a LEN-type principal-agent model with agents in two different jurisdictions. Compared to the case with separate taxation (ST) the principal demands increased effort and pays an increased compensation to managers in low-tax jurisdictions, if payroll enters the FA formula. Managers in high-tax jurisdictions face the opposite effect. Further, the composition of the compensation packages changes. Overall, net profit increases, because FA offers potential for profit shifting.

Keywords: Common Consolidated Corporate Tax Base, Formula Apportionment, Managerial Compensation, Multi-Jurisdictional Entities, Principal-Agent-Problem

JEL Classification: H25, M41

Suggested Citation

Martini, Jan Thomas and Niemann, Rainer and Simons, Dirk, Management Incentives Under Formula Apportionment – Tax-Induced Distortions of Effort and Compensation in a Principal-Agent Setting (July 10, 2014). Arqus Quantitative Tax Research Discussion Paper No. 168, Available at SSRN: https://ssrn.com/abstract=2464513 or http://dx.doi.org/10.2139/ssrn.2464513

Jan Thomas Martini (Contact Author)

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany

HOME PAGE: http://www.wiwi.uni-bielefeld.de/lehrbereiche/bwl/ctrl/martini

Rainer Niemann

University of Graz, Center for Accounting Research ( email )

Universitätsstr. 15 / G2
Graz, 8010
Austria
+43-316-380-6444 (Phone)
+43-316-380-9595 (Fax)

HOME PAGE: http://www.uni-graz.at/steuer

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Dirk Simons

University of Mannheim - Accounting and Taxation ( email )

Mannheim, 68131
Germany

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