DAVID I. WALKER, Boston University School of Law
Email: diwalker@bu.edu
VICTOR FLEISCHER, University of Illinois College of Law
Email: victor.fleischer@gmail.com

Should we require companies to report the same amount of income to the IRS as they report to their shareholders? The idea behind "book/tax conformity" is that managers' desire to increase reported earnings would act as a check on their desire to minimize taxable income, and vice versa. Some scholars have proposed a comprehensive approach, adopting financial income as the basis for corporate taxation. Legislators, meanwhile, have offered a targeted approach that singles out equity compensation, which has historically been a significant source of the "gap" between book income and taxable income.

This Article argues that book/tax conformity carries unexplored costs that reduce its attractiveness, at least in the context of equity compensation (and quite possibly in other areas as well). Conforming the employer's tax treatment of stock and options with the accounting rules creates a paradox for employee-level taxation. Either employee taxation is also conformed to book, which raises liquidity, fairness, and other concerns, or we must diverge from section 83(h), which limits the employer's deduction to the amount included by the employee as income. Severing this link between the employer's deduction and the employee's inclusion would eliminate an important check on tax gamesmanship that is analogous to the check that book/tax conformity proponents seek to create. Conforming tax deductions for options with book, in other words, may simply trade one form of gamesmanship for another.

More broadly, book/tax conformity must be evaluated in light of (1) the cost of other gamesmanship that may result from conformity, (2) the availability of other means of combating manipulation, (3) potential distortions in compensation design, and (4) effects on the decision to be a private or public company. We conclude that equity compensation should be excluded from comprehensive book/tax conformity regimes, and one-off proposals to conform employer taxation of stock and options with book are probably misguided. On the other hand, we suggest that if targeted conformity of equity compensation is desired, revising the accounting rules for options to match those of stock appreciation rights, which would yield conformity at the tax end of the spectrum, possibly could improve upon the status quo.

ULRIKE MALMENDIER, University of California, Berkeley - Department of Economics, National Bureau of Economic Research (NBER), Centre for Economic Policy Research (CEPR), Institute for the Study of Labor (IZA)
Email: ulrike@econ.berkeley.edu
GEOFFREY A. TATE, University of California, Los Angeles
Email: geoff.tate@anderson.ucla.edu

Compensation, status, and press coverage of managers in the U.S. follow a highly skewed distribution: a small number of 'superstars' enjoy the bulk of the rewards. We evaluate the impact of CEOs achieving superstar status on the performance of their firms, using prestigious business awards to measure shocks to CEO status. We find that award-winning CEOs subsequently underperform, both relative to their prior performance and relative to a matched sample of non-winning CEOs. At the same time, they extract more compensation following the award, both in absolute amounts and relative to other top executives in their firms. They also spend more time on public and private activities outside their companies, such as assuming board seats or writing books. The incidence of earnings management increases after winning awards. The effects are strongest in firms with weak governance, even though the frequency of obtaining superstar status is independent of corporate governance. Our results suggest that the ex-post consequences of media-induced superstar status for shareholders are negative.

CAROLA FRYDMAN, MIT Sloan School of Management
Email: Frydman@mit.edu
RAVEN E. SAKS, U.S. Federal Reserve - Division of Research and Statistics
Email: raven.e.saks@frb.gov

We analyze the long-run trends in executive compensation using a new panel dataset of top executives in large publicly-held firms from 1936 to 2005, collected from corporate reports. This historic perspective reveals several surprising new facts that conflict with inferences based only on data from the recent decades. First, the median real value of compensation was remarkably flat from the end of World War II to the mid-1970s, even during times of rapid economic expansion and aggregate firm growth. This finding contrasts sharply with the steep upward trajectory of pay over the past thirty years, which coincided with a period of similarly large increases in aggregate firm size. A second surprising finding is that the sensitivity of an executive's wealth to firm performance was not inconsequentially small for most of our sample period. Thus, recent years were not the first time when compensation arrangements served to align managerial incentives with those of shareholders. Taken together, the long-run trends in the level and structure of compensation pose a challenge to several common explanations for the widely-debated surge in executive pay of the past several decades, including changes in firms' size, rent extraction by CEOs, and increases in managerial incentives.

JARED D. HARRIS, University of Virginia - Darden Graduate School of Business Administration
Email: harrisj@darden.virginia.edu

I broadly explore the question by examining several common criticisms of CEO pay through both philosophical and empirical lenses. While some criticisms appear to be unfounded, the analysis shows not only that current compensation practices are problematic both from the standpoint of distributive justice and fairness, but also that incentive pay ultimately exacerbates the very agency problem it is purported to solve.

MOHAMED BELKHIR, UAE University
Email: m.belkhir@uaeu.ac.ae
ABDELAZIZ CHAZI, American University of Sharjah - School of Business & Management
Email: achazi@aus.edu

We examine the relation between executive compensation incentives to increase risk and risk-taking in a sample of 156 bank holding companies (BHCs) over the 1993-2006 period. In particular, we test whether the sensitivity of CEO stock options' portfolio to equity risk (vega), as a measure of incentives to increase risk, has an effect on market risk measures of BHCs. We also analyze the trend over time of the incentives to increase risk provided to bank CEOs, and examine the determinants of such incentives. Our evidence shows that the incentives to increase risk provided to bank CEOs through compensation have increased significantly as we moved towards a more deregulated banking environment. We also find that investment opportunities, bank size, and CEO stock ownership are among the determinants of the magnitude of the incentives to increase risk granted to bank CEOs. This result is consistent with bank shareholders providing their managers with incentives to take on higher risks when the potential loss from risk-aversion is greatest. Regarding the vega-bank risk relation, our findings indicate that there is a positive effect of CEO-compensation vega on market risk measures, suggesting that greater incentives to increase risk induce higher risk-taking by bank managers. We also test for a quadratic relation between vega and bank risk and find evidence of a concave effect of compensation vega on our risk measures. This last result suggests that even in the presence of high executives' incentives to increase risk, risk-taking in the banking industry is limited by other factors.

JOSEPH GERAKOS, University of Chicago - Graduate School of Business
Email: jgerakos@chicagogsb.edu

This study investigates the extent to which chief executive officers (CEOs) trade pay for pension benefits. For a sample of S&P 500 CEOs, I find that an additional dollar of pension benefits is associated with a 48 cent decrease in pay measured as the sum of cash compensation and equity grants. Although the tradeoff estimate is significantly different from zero, it is also significantly less than the anticipated rate of dollar for dollar, especially for more powerful CEOs. This implies that the implicit price of pension benefits decreases with the CEO's power, so pooling datasets on CEOs with varying degrees of power blurs the size of the pay-pension tradeoff.

AILSA RÖELL, Princeton University - Bendheim Center for Finance
Email: aroell@princeton.edu

The paper examines the impact of executive compensation on private securities litigation. We find that incentive pay in the form of options increases the probability of securities class action litigation, holding constant a wide range of firm characteristics. We further document that there is abnormal upward earnings manipulation during litigation class periods and that insiders exercise more options and sell more shares during class periods, but that this activity is largely driven by pre-existing option holdings of the managers. Our results suggest that option-based compensation may have the unintended side effect of giving executives an incentive to focus excessively on the short term share price.