Junior Management Science, Volume 6, Issue 1, March 2021, 100-148

The Impact of Taxation on Managerial Incentives and the Use of Bonus Banks

Daniel Dyck, Bielefeld University (Master Thesis)

This study examines how taxes and tax code features influence a firm owner´s use of a managerial incentive scheme known as bonus bank. Bonus banks have a unique property: part of the manager´s earned bonus in one period is withheld and subsequently paid out only in case future period´s firm goals are met. While prior literature on bonus banks either neglected taxes or took managerial incentives as given, I incorporate both aspects into a multi-period agency model with a risk neutral, limited liability agent. The model especially captures corporate income taxes, loss-offset restrictions as well as a manager´s flat, period-dependent income tax rate. The results are twofold: First, compared to fixed remuneration contracts, the use of bonus banks is adversely affected by all investigated taxes and tax code features, except for the loss-offset restrictions. Second, compared to periodical bonus remuneration, bonus banks possess an income smoothing characteristic, weakening the negative effect loss-offset restrictions and income tax progressivity have on a firm owner´s future value. Overall, the results complement the literature on the decision relevance of taxes when designing compensation contracts.

Keywords: Principal Agent Theory, Tax Effects, Bonusbank, multi-periodical contract-structure.