Compensation and Taxes: Evidence from Relative Performance Evaluation

Relative performance evaluation (RPE) is a common practice in compensation contracting, essentially conditioning management compensation on the achievement of certain performance goals relative to a benchmark. In this paper, we examine the incentive effects of RPE usage on tax outcomes. We predict and find that low-tax peers in RPE contracts influence focal firm tax outcomes. Specifically, we find that a greater proportion of low-tax RPE peers embedded in RPE compensation contracts is associated with lower book and cash effective tax rates, and we find evidence that this effect is not confined to RPE peers within the same industry. Moreover, we also find that the tax outcomes incentivized through low-tax RPE peers occurs through RPE grants conditional on achieving after-tax earnings metrics. Overall, our results reveal that RPE provides a meaningful influence on corporate tax outcomes.