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Why Taxing Executives' Bonuses Can Foster Risk-Taking Behavior

  • Martin Grossmann

    ()

    (Department of Business Administration, University of Zurich)

  • Markus Lang

    ()

    (Department of Business Administration, University of Zurich)

  • Helmut Dietl

    ()

    (Department of Business Administration, University of Zurich)

Bonus taxes have been implemented to prevent managers from taking excessive risks. This paper analyzes the effects of taxing executives' bonuses in a principal--agent model. Our model shows that, contrary to its intention, the introduction of a bonus tax intensifies managers' risk-taking behavior and decreases their effort. The principal responds to a bonus tax by offering the manager a higher fixed salary but a lower incentive-based component (bonus rate).

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File URL: http://repec.business.uzh.ch/RePEc/iso/ISU_WPS/150_ISU_full.pdf
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Paper provided by University of Zurich, Institute for Strategy and Business Economics (ISU) in its series Working Papers with number 0150.

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Length: 26 pages
Date of creation: Oct 2011
Date of revision: May 2012
Handle: RePEc:iso:wpaper:0150
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  1. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  2. Helmut Dietl & Martin Grossmann & Markus Lang & Simon Wey, 2010. "Incentive Effects of Bonus Taxes in a Principal-Agent Model," Working Papers 0140, University of Zurich, Institute for Strategy and Business Economics (ISU), revised Feb 2012.
  3. Bengt Holmstrom, 1997. "Moral Hazard and Observability," Levine's Working Paper Archive 1205, David K. Levine.
  4. Anthony M. Marino & Ján Zábojník, 2008. "Work-related perks, agency problems, and optimal incentive contracts," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 565-585.
  5. James A. Mirrlees, 1976. "The Optimal Structure of Incentives and Authority Within an Organization," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 105-131, Spring.
  6. Michael Faulkender & Dalida Kadyrzhanova & N. Prabhala & Lemma Senbet, 2010. "Executive Compensation: An Overview of Research on Corporate Practices and Proposed Reforms," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(1), pages 107-118.
  7. Thanassoulis John, 2009. "Now Is the Right Time to Regulate Bankers' Pay," The Economists' Voice, De Gruyter, vol. 6(5), pages 1-4, April.
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