A Theory of Managerial Compensation and Taxation with Endogenous Risk

C. Gizem Korpeoglu (Corresponding author), Stephen E. Spear

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

We study the impact of endogenous shocks driven by collective actions of managers. We analyze how such endogenous shocks impact social welfare by employing an overlapping-generations model. We first prove that the competitive equilibrium allocation is suboptimal because of the externalities in managers’ wages and in equity market. We establish that a socially optimal allocation can be achieved if the planner imposes wage taxes (or subsidies) on managers and equity taxes. Our results help provide an alternative explanation as to why managers are compensated and taxed differently than other workers. We then extend the model by incorporating unobservable actions for managers and show that a second-best allocation can be implemented if the planner imposes equity taxes.
Original languageEnglish
Pages (from-to)81-100
JournalEconomic Theory Bulletin
Volume6
Issue number1
DOIs
Publication statusPublished - Apr 2018
Externally publishedYes

Keywords

  • Endogenous uncertainty
  • Social welfare
  • Externality
  • Overlapping generations

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