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

We quantify the effects of personal income taxes on executive compensation in the US. Controlling for other determinants of compensation and addressing endogeneity concerns, CEOs receive an abnormal increase in pay of 6.4% to 7.4% following large state income tax increases, relative to pay growth of CEOs who do not experience such tax shocks. Pay increases within two years by an amount that more than fully compensates the CEO for the increased tax liability.  The increase in pay is larger when: there are more employment options in the industry and the CEO is less tied personally to the company; the firm is more profitable and the CEO-firm match is more valuable; and governance is doubtful (high E-index, low board independence).  In stark contrast, CEOs and other NEOs do not experience a cut or slower growth in pay following a tax cut. The asymmetry in the income tax effect and the size of the response to increases suggest that both supply-demand considerations and agency concerns associated with rent extraction affect the change in CEO pay.