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1、The RoleofCompensation-BasedIncentives （）John D. Phillips University of ConnecticutABSTRACTThis study investigates whether compensating chief executive officers andbusiness-unit managers using after-tax accounting-based performance measures leads to lower effective tax rates, the empirical surrogate

2、 used for tax-planning effectiveness. Utilizing proprietary compensation data obtained in a survey of corporate executives, the relation between effective tax rates and after-tax performance measures is modeled and estimated using a two-step approach that corrects for the endogeneity bias associated

3、 with firms decisions to compensate managers on a pre- versus after-tax basis. The results are consistent with the hypothesis that compensating business-unit managers, but not chief executive officers, on an after-tax basis leads to lower effective tax rates.KEYWORDStax planning;performance measures

4、;endogenous treatment effects.I. INTRODUCTIONEffective tax planning, defined by Scholes et al. （2002） as tax planning that maximizes the firms expected discounted after-tax cash flows, requires managers to consider their decisions after-tax consequences. In this paper, I investigate whether after-ta

5、x accounting-based performance measures lead to lower effective tax rates （ETR）, my empirical surrogate for tax planning effectiveness.1 The ETR, an income-statement-based outcome measure calculated as the ratio of total income tax expense to pre-tax income, generally measures the effectiveness of t

6、ax reduction strategies that lead to higher after-tax income. A lower ETR, however, can only proxy for tax savings and does not always imply that after-tax income and/or cash flows have been maximized.2 Despite this limitation, the ETR has been used to measure the effectiveness of spending on the ta

7、x function （Mills et al. 1998） and corporate tax department performance （Douglas et al. 1996）. Also, lowering the ETR is frequently cited as a way to increase earnings （e.g., Ziegler 1997） and increase share price （e.g., Mintz 1999; Swenson 1999）.Accounting research has addressed the relation betwee

8、n accounting-based compensation and managers actions （e.g., Larcker 1983; Healy 1985; Wallace 1997）. This paper is the first to address whether after-tax accounting-based performance measures motivate managers to take actions that help lower their firms ETR and does so at both the chief executive of

9、ficer （CEO） and business-unit （SBU） manager levels.17Prior after-tax performance measure research has focused only on the determinants of compensation CEOs using pre- versus after-tax earnings （e.g., Newman 1989; Carnes and Guffey 2000; Atwood et al. 1998; Dhaliwal et al. 2000） and provides no evide

10、nce concerning after-tax compensations effectiveness in lowering a firms tax liability. Extending this investigation to the SBU level is motivated out of the apparent conflict between arguments that taxes should be allocated toSBU for incentive compensation purposes （e.g., McLemore 1997） with empiri

11、cal observations that a majority of firms do not do so （e.g., Douglas et al. 1996）.4 The current investigation provides evidence concerning the incremental effectiveness of explicitly motivating CEOs and SBU managers to incorporate tax consequences into their operating and investment decisions.A com

12、mon issue in cross-sectional studies that attempt to link a particular management accounting choice to an outcome measure is that all sample firms may be optimizing with respect to the choice being investigated （Ittner and Larcker 2001）. Without addressing the endogeneity of a firms choice, it is di

13、fficult to provide evidence consistent with this choice leading to an improved outcome. To address this issue, the relation between ETR and CEO andSBU-manager after-tax performance measures is estimated using a two-step approach that helps correct for the potential endogeneity bias associated with t

14、hese two choice variables. As a first step in implementing this approach, the Antle and Demski （1988） controllability principle is used to model a firms decisions to adopt after-tax CEO and SBU-manager performance measures. To include a particular measure in a managers compensation contract, this pr

15、inciple requires that the expected benefits from holding a manager responsible for a measure must be greater than the additional wage that must be paid to compensate the manager for the resulting additional risk and effort. Accordingly, an after- tax performance measure should be used as a contracti

16、ng variable in a managers incentive compensation contract only if the managers involvement in tax-planning efforts leads to a difference between pre-tax and after-tax accounting results, which is generally reflected in the ETR. Consistent with prior research, the pre- versus after-tax CEO and SBU-manager selecti