THE IMPACT OF INTERNAL REVENUE CODE SECTION 162(M) ON PAY FOR PERFORMANCE: A REEXAMINATION

• Main Author: Ren, Yi
• Format: Others
• Published: OpenSIUC 2010
• Online Access: https://opensiuc.lib.siu.edu/dissertations/122; https://opensiuc.lib.siu.edu/cgi/viewcontent.cgi?article=1122&context=dissertations

I examine the effects of Internal Revenue Code Section 162(m), which caps a public company's corporate income tax deduction at $ 1 million per year for amounts paid to each of its top five executives, on CEO compensation level, CEO compensation structure and pay for performance sensitivity. I find that the average level of CEO salary decreased after the implementation of Section 162(m) and that firms that paid their CEOs salary no less than $1 million have constrained their CEO salary growth after Section 162(m). However, the level of CEO total compensation does not follow the same trend as the level of CEO salary. In particular, the average total compensation increased after enactment of Section 162(m) and the increases in bonuses and equity-based compensation were main contributions to the upward trend of total compensation. To examine whether Section 162(m) create closer association between pay and performance, I examine whether performance sensitivity of CEO bonuses and total compensation increased after Section 162(m). I do not find evidence to support the position that pay-for-performance sensitivity has changed after Section 162 (m) compared to that before Section 162(m). I then further probe the long-term effect of Section 162(m) on pay-for-performance sensitivity. I find the firms most likely to be affected by the tax regulation showing increased sensitivity of total compensation growth to sales growth and ROA growth over the later post-Section 162(m) period compared to the earlier post-Section162 (m) period. My finding provides evidence that firms most likely to be affected by this tax code, in order to preserve their tax deductibility, will more likely to comply with the recently adopted rules and legislation (regulations imposed after the Enron- era). Overall, my results suggest that firms that paid their CEOs salaries more than $ 1million have constrained their fixed salary growth after Section 162(m), while the average total compensation actually increased after Section 162(m). Also, such firms are more likely to alter their CEO compensation package by using more performance related compensation than using fixed salary. According to my results, there are no significant differences in pay-for-performance sensitivity before and after Section 162(m), but I document a long-term effect of Section 162(m) on pay-for-performance sensitivity.