The Impact of Taxes on Competition for CEOs

Abstract

This paper contributes to the question of how taxation of corporate profits and wages affects competition among firms for highly skilled human resources such as CEOs. Use of a theoretical model shows that wage taxes can have a substantial impact on the outcome of such a competition if marginal tax rates are different as in an international labor market. Further, the paper shows that increasing the wage tax rate unilaterally can have an ambiguous effect on observed gross compensation levels. However, in a local labor market for CEOs, observed gross fixed salaries should decline in the wage tax rate. Tax effects in a market for CEOs is a particularly interesting topic because recent developments with respect to compensation practices of top-level managers have opened a public debate about the use of instruments for regulating compensation of those managers. Furthermore, many countries around the world use tax incentives in order to facilitate immigration of highly skilled human resources. The investigation follows an analytical economics-based approach by extending an LEN model with elements of competition for scarce human resources and income taxation. It investigates the impact of differential taxation on the competition between two firms for the exclusive service of a unique, highly skilled CEO.

Taxation and agency conflicts between firm owners and managers: a review

“…Nearly all authors assume that the reservation utility is not affected by wage taxation (for an exception see Krenn 2017). However, neglecting wage tax effects on the reservation utility is problematic, for example, when the model includes multiple agents.…”

“…Consequently, the incentive for agents with a low productivity to mimic highly productive agents is reduced and the misallocation of effort is mitigated. Krenn (2017) shows that the interaction of competition for highly skilled CEOs and incentive schemes directly depends upon the wage tax rate if two principals located in different tax jurisdictions compete for a single agent. In his model, wage taxation affects the agent's reservation utility, and thus the principal's contract offer to the agent.…”

Regulatory Compensation Limits and Business Performance Evidence from the National Football League

“…The research -especially empirical research -on such measures and their influence on CEO pay but also on the performance of the affected firm is very scarce. Krenn (2016) analyses theoretically the influence of (special) wage taxes on CEO remuneration on the hiring process of CEOs. He finds that when two companies compete for hiring the same individual to become their CEO the personal income tax rate of the CEO can alter the competition.…”

“…For instance, in the U.S. the CEO-to-worker compensation increased from a ratio of 20-to-1 in 1965 to a ratio of 510.7-to-1 in 2013 with an average CEO pay of USD 24.8 million (Mishel, and Davis 2014). Similarly, in 2014 the average CEO pay disclosed by UK FTSE 100 firms was 125 times the average employee pay pointing to a mismatch regarding compensation levels (Krenn 2016).…”

“…Scientific research has shown that many companies try to attract the seemingly most talented individuals for directors and higher management positions by offering compensation packages (fixed salary and performance based bonuses) that appear to be far beyond the compensation levels of regular workers (see Frydman, and Jenter (2010); Krenn (2016)). For instance, in the U.S. the CEO-to-worker compensation increased from a ratio of 20-to-1 in 1965 to a ratio of 510.7-to-1 in 2013 with an average CEO pay of USD 24.8 million (Mishel, and Davis 2014).…”