The Association Between Book-Tax Differences and CEO Compensation

Kin-Wai Lee and Gillian Hian-Heng Yeo

Chapter 32 in Handbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning:(In 4 Volumes), 2020, pp 1245-1269 from World Scientific Publishing Co. Pte. Ltd.

Abstract: We examine the effect of book-tax differences on CEO compensation. We posit that CEOs can opportunistically exercise the discretion in GAAP to increase accounting income without affecting taxable income and in so doing increase their compensation. We test the data to determine which competing hypothesis dominates — efficiency or rent-seeking. Under the efficiency hypothesis, the board of directors uses the information in book-tax differences to undo CEOs’ attempts to artificially inflate accounting income and hence CEO compensation is negatively associated with book-tax differences. Under the rent-seeking hypothesis, CEOs gain effective control of the pay-setting process so that they set their own pay with little oversight from shareholders and directors. Directors do not use the information in book-tax differences to undo CEOs’ attempted earnings manipulation and this gives rise to a positive association between CEO compensation and book-tax differences. Consistent with the efficiency hypothesis, we find that CEO compensation is negatively associated with book-tax differences suggesting that directors use the information in book-tax differences to reduce excessive CEO compensation. We also find that strong corporate governance structure strengthens the negative association between CEO compensation and book-tax differences. Specifically, firms with high insider equity ownership and high proportion of independent directors on the board have lower CEO compensation when book-tax differences are large.

Keywords: Financial Econometrics; Financial Mathematics; Financial Statistics; Financial Technology; Machine Learning; Covariance Regression; Cluster Effect; Option Bound; Dynamic Capital Budgeting; Big Data (search for similar items in EconPapers)
JEL-codes: C01 C1 G32 (search for similar items in EconPapers)
Date: 2020
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.worldscientific.com/doi/pdf/10.1142/9789811202391_0032 (application/pdf)
https://www.worldscientific.com/doi/abs/10.1142/9789811202391_0032 (text/html)
Ebook Access is available upon purchase.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:wschap:9789811202391_0032

Ordering information: This item can be ordered from

Access Statistics for this chapter

More chapters in World Scientific Book Chapters from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().