A Theory of Managerial Compensation and Taxation with Endogenous Risk
20 Pages Posted: 1 Feb 2016 Last revised: 30 Sep 2017
Date Written: January 31, 2016
We study the impact of endogenous shocks driven by collective actions of managers. We analyze how such endogenous shocks impact social welfare by employing an overlapping-generations model. We first prove that the competitive equilibrium allocation is suboptimal because of the externalities in managers' wages and in equity market. We establish that a socially optimal allocation can be achieved if the planner imposes wage taxes (or subsidies) on managers and equity taxes. Our results help provide an alternative explanation as to why managers are compensated and taxed differently than other workers. We then extend the model by incorporating unobservable actions for managers and show that a second-best allocation can be implemented if the planner imposes equity taxes.
Keywords: Endogenous Uncertainty; Social Welfare; Externality; Overlapping Generations
JEL Classification: D51, D61, D62
Suggested Citation: Suggested Citation