This study explores corporate responses to 1993 legislation that capped the corporate tax deductibility of top management compensation not qualified as “performance‐based.” Our analysis suggests that the cap may have created a focal point for salary compensation but had little effect on total compensation levels or growth rates at firms likely to be affected by the limit. There is little evidence that the policy significantly increased the performance sensitivity of chief executive officer (CEO) pay at affected firms. We conclude that corporate pay decisions have been relatively insulated from this policy intervention.

The negative effect of quits on the willingness of firms to provide on‐the‐job training is well documented in the theoretical literature. Here we explore the strength of this effect by solving a firm’s dynamic optimization problem where there is uncertainty about future productivity and nonzero firing costs. We find that the degree to which quit rates affect hiring depends on the ratio of firing to hiring costs. As this ratio rises, the negative effect of quits becomes less important, eventually reversing itself. We also describe how quit rates affect the firing decision. We highlight some testable implications of our analysis.