Theory suggests that changes in corporate tax rates can alter the dispersion of after-tax project payoffs, thereby altering the exposure of firm-level risk transmitted to executives through compensation. Using state tax changes, we observe firms shifting away from option-based compensation following state corporate tax rate increases. This result is concentrated in compensation contracts that lack relative performance evaluation (RPE) features, which filter common shocks to performance and influence the type of risk executives are incentivized to take. We also find that firms are more likely to initiate RPE shortly after a state tax rate increase and that firms that adjusted compensation through reductions in equity risk incentives or used RPE were less likely to experience a subsequent increase in systematic risk following a state tax rate increase. Overall, our findings provide novel insight into how taxes can influence CEO compensation design and the transmission of firm-level risk to executives. Data Availability: Data are obtained from public sources identified in the paper.

When determining new equity grants, corporate boards face a tradeoff between the CEO’s incentives generated from the grant’s duration versus those arising from the convexity of the embedded equity risk. We hypothesize and find that boards lengthen the horizon of new compensation grants in the presence of greater pre-existing compensation sensitivity to stock return volatility (vega). In addition, consistent with our hypothesis, we find stronger results in the presence of greater left-tail risk. Further, employing two exogenous shocks to left-tail risk, we provide evidence consistent with our hypothesis that grant horizons are related to risk incentives. Our analysis of the interaction of these two incentive mechanisms provides new insights on compensation contracting.

Social hierarchy theory predicts that the power and status of an organizational function have a first-order effect on the function's ability to influence outcomes. We find that the rank of the title of the top tax executive is positively associated with tax planning after controlling for treatment effects. Our inferences remain when (1) using changes in the size of the c-suite as a shock to the relative power and status of the tax function, and (2) examining promotions and demotions in title rank. Point estimates suggest that tax function power and status are up to 2.6 times as important as tax planning resources, up to 4.0 times as important as tax function-specific expertise, and, more often than not, more important than manager fixed effects. Overall, results suggest that the power and status of the tax function is often what matters most in determining tax outcomes.

We investigate why firms choose to evaluate a tax department as a profit center (“contributor to the bottom line”) as opposed to as a cost center and the association between this choice and effective tax rates (ETRs). Using data from a confidential survey taken in 1999 of Chief Financial Officers, we develop and test a theory for choosing between these two methods of evaluating a tax department. We find that the likelihood of evaluating the tax department as a profit center is increasing in firm decentralization characteristics and tax-planning opportunities. We then employ instrumental variables to investigate whether evaluating a tax department as a profit center provides an effective incentive for the tax department to contribute to net income through lower ETRs. We find that our instrument for profit center firms is associated with significantly lower ETRs than cost center firms.

Under U.S. GAAP, firms recognize assets acquired in business combinations at fair value. Similarly, in taxable asset acquisitions firms adjust the tax basis of assets to fair value. Managers can increase the present value of future tax savings by allocating a greater portion of the purchase price to shorter‐lived assets than to goodwill or indefinite‐lived intangibles. However, this tax planning strategy imposes a financial reporting cost because it reduces book income following the acquisition; all else equal, allocations to shorter‐lived depreciable assets increase book depreciation expense, whereas allocations to goodwill and indefinite‐lived intangibles do not increase book amortization expense. We exploit the features of taxable asset acquisitions to investigate trade‐offs between tax and financial reporting incentives. We predict and find greater allocations to depreciable versus intangible assets when managers have strong tax incentives and weak financial reporting incentives. However, we also find that strong financial reporting incentives moderate the effects of strong tax incentives. These findings contribute new evidence to the literature on the importance of nontax costs in tax planning decisions