How Executive Compensation Changes In Response to Personal Income Tax Shocks (Who Pays the CEO’s Income Taxes?)

We study the effects of personal income tax on executive compensation. Using a difference-in-differences approach based on large shocks to personal income tax rates, we find CEOs receive higher pay two years after tax increases. The higher tax burden drives CEOs to sell stock of their firms for liquidity reasons. Accordingly, boards increase equity-based pay to strengthen incentives. Pay raises after tax increases are negatively associated with CEO turnover, while the lack of a pay raise leads to lower firm performance. The effect of personal income tax on compensation is asymmetric; CEOs do not receive pay cuts following tax cuts.