Taxation, Career Concerns and CEO Pay

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Money Macro Seminar
University of Pennsylvania

3718 Locust Walk
395 McNeil

Philadelphia, PA

United States

This paper proposes a simple dynamic model of equilibrium CEO compensation. The focus of the theory is on the quality of talent identification in the economy and the efficiency in the assignment of managers to firms. Motivated by the strengthened career incentives stemming from the fall in the top income tax rates over the past decades, in particular in the US, I study the implications of a model where the quality of talent identification depends on how hard individuals are willing to work in order to be among the winners in the contest for managerial positions. It is shown how the compensation of CEOs can be interpreted in this light, both across time and across industries, and I provide some evidence showing that the predictions of the model are in line with several important empirical developments over the past decades. In essence, the paper shows how stiffer competition for promotions in the labor market as a response to lower tax rates offers an explanation for the growth in CEO compensation.

For more information, contact Dirk Krueger.

Martin Holte

Stockholm University