The effect of addback statutes on CEO compensation

Many U.S. states responded to companies’ shifting of taxable income to states with low or no taxes by adopting addback statutes, which significantly decreased the after-tax income of companies headquartered in those states. We exploit the adoption of these addback statutes, which occurred at different times, as exogenous shocks to taxable income, to examine the effect of tax policy changes on compensation of chief executive officers (CEOs). Using a difference-in-differences design, we provide evidence that CEOs of firms headquartered in states affected by addback statutes experienced a decrease in total compensation, mainly driven by decreases in salaries and bonuses. In cross-sectional tests, we document that the relationship between CEO compensation and these tax policies is stronger for firms with higher levels of intangibles and asset replacement costs relative to book values, and weaker for firms whose CEOs are more powerful relative to the board of directors. Our results have important implications for policymakers who strive to combat pay inequality and managerial myopia through tax laws