An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Robert Halperin
The Hong Kong Polytechnic University

Richard Sansing
Dartmouth College & Tilburg University

Abstract: This paper examines measures of tax planning effectiveness using a multi-task principal-agent model. It derives the optimal linear incentive contract, which depends on the value of the firm’s output, its tax savings from permanent book-tax differences, and its deferred tax expense. The weights on these three performance measures depend on the marginal product of the agent’s action and the noise in the performance measures. In contrast, the effective tax rate is a non-linear function of these performance measures. The paper shows that the change in the effective tax rate due to the agent’s actions is systematically different than the change in the principal’s tax burden due to these actions, which suggests that the effective tax rate is not an effective performance measure.

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