How Executive Compensation Changes In Response To Personal Income Tax Shocks

We examine how executive compensation responds to personal income tax shocks using changes in U.S. state tax rates from 1992 to 2022.  CEO pay increases by 6.4% to 7.4% two years after a large state tax increase but does not decline following a state tax cut.  Estimates based on changes in net-of-tax rates imply that firms absorb most of the additional tax burden and that the supply of CEO services is substantially more elastic than firm demand.  The pay response is stronger when CEOs have more outside employment opportunities and are less attached to the firm, but not when corporate governance is weaker.  The evidence supports a competitive labor-market mechanism rather than governance-based rent extraction and indicates that the incidence of state personal income taxes falls largely on firms.