A Theory of Managerial Compensation and Taxation with Endogenous Risk

20 Pages Posted: 1 Feb 2016 Last revised: 30 Sep 2017

See all articles by C. Gizem Korpeoglu

C. Gizem Korpeoglu

Eindhoven University of Technology

Stephen Spear

Carnegie Mellon University - Financial Economics

Date Written: January 31, 2016

Abstract

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

Korpeoglu, C. Gizem and Spear, Stephen E., A Theory of Managerial Compensation and Taxation with Endogenous Risk (January 31, 2016). Economic Theory (Bulletin), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2725446 or http://dx.doi.org/10.2139/ssrn.2725446

C. Gizem Korpeoglu (Contact Author)

Eindhoven University of Technology ( email )

PO Box 513
Eindhoven, 5600 MB
Netherlands

Stephen E. Spear

Carnegie Mellon University - Financial Economics ( email )

GSIA
Schenley Park
Pittsburgh, PA 15213
United States

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