Is the Market Grossed out by Gross-Ups? An Investigation of Firms that Pay Their CEOs' Taxes

Abstract

This study provides evidence on whether investors value tax gross-up provisions for executives, and how the elimination of these provisions changes executive compensation. We examine the market response to tax gross-up eliminations and find investors react favorably to the removal of these provisions, suggesting that on average, investors perceived these agreements as a bad compensation practice that destroyed firm value. Next, we examine whether firms respond to these eliminations by increasing other forms of executive compensation. We find firms eliminating tax gross-up provisions increase bonus but not salary. Broadly, we provide evidence that some features of compensation contracts are not valued by shareholders, and that the elimination of these features can lead to increased firm value.

Keywords: Executive Compensation, Corporate Governance, Tax, Tax Gross-Up

JEL Classification: J33, J41, H24, H25, G14, G18