In the Nick of Time: Performance-Based Compensation and Proactive Responses to the Tax Cuts and Jobs Act

Abstract

ABSTRACT The Tax Cuts and Jobs Act of 2017 (TCJA) introduced two major changes that may influence executive compensation: (1) reducing corporate tax rates from 35 to 21 percent, and (2) eliminating the performance-based pay exception in Section 162(m). These changes provide incentives to maximize deductible compensation expense in 2017, before the TCJA goes into effect. Consistent with our expectation, we find that the increase in CEO bonus and stock option compensation is significantly greater in 2017 relative to prior years. Our difference-in-differences results are consistent with the tax rate reduction driving the bonus increase and the repeal of the performance-based exception leading to the increase in CEO stock options. The TCJA also changed the definition of covered employees to include the CFO. We find weak evidence for abnormal increases in CFO performance-based compensation. Overall, our findings suggest that firms responded to the TCJA in the period before it was effective.