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Is Limiting the Deductibility of Executive Compensation Serving the Public Interest? An Analysis of the Highest Paid CEOs Using Data Envelopment Analysis
Elizabeth T. Cole, University Of South Carolina Upstate
Diane A. Riordan, James Madison University
ABSTRACT. Responding to public concern for excessive executive compensation, Congress amended Section 162 of the Internal Revenue Code to set a limit of one million dollars on the deduction corporations are allowed when compensating executives. To deduct compensation in excess of the limit, the compensation must be structured as a reward for performance. In spite of the limit on non-performance based pay, agency and contracting theories predict increases in total compensation costs in response to the amended code. Prior studies demonstrated that compensation packages have become more sensitive to performance and increased. No study has directly tested if the gains from increased incentive have outweighed the cost of increased compensation. Using data envelopment analysis and supporting statistical techniques, our analysis provides empirical evidence that compensation packages have become inefficient for certain firms and their shareholders during the period following the tax law change.
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