EXECUTIVE COMPENSATION CONTRACTING AND RESPONSES TO INCREASED TAX COSTS

I investigate how changes in compensation received by firms' chief executive officers (CEOs) were affected by firms' responses to a tax law change, enactment of S 162(m), which limited the deductibility of executive compensation. The tax change was an exogenous shock to compensation contracting and resulted in firms facing potentially higher tax costs and CEOs facing potentially riskier compensation. I test how taxes were shared between the CEO and the firm and how the risk borne by the CEO changed as a result of firms' responses to S 162(m). Additionally, I investigate the effect of S 162(m) on the relation between compensation and both financial performance measures and corporate governance. Also, I consider what effect changes in contract risk had on CEOs' compensation.; The evidence indicates that firms responding to S 162(m) altered the types of compensation awarded. Firms that faced a salary constraint because salary was already at the deductibility limit increased salary less than other firms in the post-enactment period but compensated the CEO for the lower increase by awarding other riskier forms of compensation. On average, bonus changes were lower and salary changes were higher for firms which qualified their bonus plan, indicating that the bonus plan was riskier. However, firms qualifying their plans by including negative discretion may have circumvented the intent of "reducing excessive compensation" and paid higher bonuses as a result. Additionally, I find some evidence that affected firms tied a greater amount of bonus to earnings in the post-enactment period.