The 'Hidden' Tax Cost of Executive Compensation

Abstract

The sweeping tax reform enacted in December 2017 will significantly increase the tax cost of executive compensation in publicly held corporations where the compensation for each of the top five executives exceeds $1 million. Nonetheless, it is unlikely that these corporations will reduce the executive compensation to offset the increased tax cost, which will likely be shifted to public shareholders.

This Essay shows that this significant tax cost is not transparent to shareholders. Our analysis of a hand-collected dataset of relevant proxy statements that were filed in the first fifty days after the enactment of the tax reform reveals that companies do not provide their shareholders with sufficient information about the tax cost of executive compensation.

Therefore, there is a need for a prompt regulatory response. To make the tax cost of executive compensation fully transparent, this Essay proposes that the Securities and Exchange Commission (SEC) should adopt new disclosure requirements, outlined in this Essay, as soon as possible. The disclosure of the tax cost of executive compensation would significantly improve the accuracy of investor information regarding the overall cost of executive compensation, and it could enhance shareholders’ ability to scrutinize compensation practices, all while imposing minimal compliance costs upon firms.

Keywords: 162(m), executive compensation, tax reform, deduction, proxy statement

JEL Classification: K22, K34, M12