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Do Tax Cuts Encourage Rent-Seeking by Top Corporate Executives? Theory and Evidence

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  • Dana Andersen
  • Ramón López

Abstract

This paper seeks to understand the role of tax policy in executive rent-seeking within the firm and income. While a longstanding literature maintains that executives are afforded discretion in obtaining rents, that the degree of exercising this discretion is influenced by tax policy is, however, not considered in the analysis of tax policy. We propose a simple model of executive pay, where executive effort (all value-creating activities) and rent-seeking (all value-diverting activities) are determined endogenously. The model shows that, under some conditions, rent-seeking, as well as effort, responds to changes in marginal tax rates. Moreover, (1) a positive association between the elasticity of taxable income with respect to the tax policy and the degree in which the internal institutions of the firm favor executives vis-à-vis shareholders, and (2) a negative association between the elasticity of taxable income and the executive's equity-at-stake, are manifestations of tax policy influencing rent-seeking. We empirically test these implications and find results that are consistent with the predictions of the model.

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Bibliographic Info

Paper provided by University of Chile, Department of Economics in its series Working Papers with number wp360.

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Length: 36 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:udc:wpaper:wp360

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Web page: http://www.econ.uchile.cl/
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  1. Brian J. Hall & Jeffrey B. Liebman, 2000. "The Taxation of Executive Compensation," NBER Working Papers 7596, National Bureau of Economic Research, Inc.
  2. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
  3. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  4. Frydman, Carola & Molloy, Raven S., 2011. "Does tax policy affect executive compensation? Evidence from postwar tax reforms," Journal of Public Economics, Elsevier, vol. 95(11), pages 1425-1437.
  5. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 49-70, Summer.
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  7. Rosen, Sherwin, 1981. "The Economics of Superstars," American Economic Review, American Economic Association, vol. 71(5), pages 845-58, December.
  8. Sanford Grossman & Oliver Hart, . "An Analysis of the Principal-Agent Problem," Rodney L. White Center for Financial Research Working Papers 15-80, Wharton School Rodney L. White Center for Financial Research.
  9. Lucian Bebchuk & Alma Cohen & Allen Ferrell, 2009. "What Matters in Corporate Governance?," Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 783-827, February.
  10. Mankiw, N. Gregory & Weinzierl, Matthew Charles & Yagan, Danny Ferris, 2009. "Optimal Taxation in Theory and Practice," Scholarly Articles 4263739, Harvard University Department of Economics.
  11. Emmanuel Saez & Joel B. Slemrod & Seth H. Giertz, 2009. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," NBER Working Papers 15012, National Bureau of Economic Research, Inc.
  12. Tuomala, Matti, 1990. "Optimal Income Tax and Redistribution," OUP Catalogue, Oxford University Press, number 9780198286059, October.
  13. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  14. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc.
  15. Nada, Eissa & Giertz, Seth, 2006. "Trends in High Incomes and Behavioral Responses to Taxation: Evidence from Executive Compensation and Statistics of Income Data," MPRA Paper 17604, University Library of Munich, Germany.
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