Equity Compensation and Tax Sheltering: Are They Negatively Related due to Incentives or Tax Benefits?
46 Pages Posted: 5 Aug 2011 Last revised: 15 Aug 2018
Date Written: April 23, 2012
We examine two competing explanations for the negative relation between equity compensation and tax sheltering documented in prior research. The first explanation suggests that equity compensation aligns managerial interests and reduces managers’ incentives to invest in tax shelters that facilitate rent extraction. The second explanation predicts that tax benefits from equity compensation reduce firms’ demand for tax shelters by lowering the marginal benefit of further tax avoidance. Using both cross-sectional and time-series tests, we find evidence that the negative relation more likely results from the tax benefits of equity compensation. This evidence suggests that it is the tax benefits from equity compensation, and not incentive alignment, that drives the observed negative relation. Our findings imply that researchers who study tax avoidance in the context of agency problems should consider the tax benefits of equity compensation as a primary influence.
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Keywords: stock option compensation, tax sheltering
JEL Classification: H26, M41, M52
Suggested Citation: Suggested Citation