This paper examines the responsiveness of taxable income to changes in marginal tax rates using detailed compensation data on several thousand corporate executives from 1991 to 1995. The data confirm that the higher marginal rates of 1993 led to a significant decline in taxable income. Indeed, this small group of executives can account for as much as 20 % of the aggregate change in wage and salary income for approximately the one million richest taxpayers; one person alone can account for more than 2%. The decline, however, is almost entirely a short-run shift in the timing of compensation rather than a permanent reduction in taxable income. The short-run elasticity of taxable income with respect to the net of tax share exceeds one but the elasticity after one year is at most 0.4 and probably closer to zero. Breaking out the tax responsiveness of different types of compensation shows that the large short-run responses come almost entirely from a large increase in the exercise of stock options by the highest income executives in anticipation of the rate increases. Executives without stock options, executives with relatively lower incomes, and more conventional forms of taxable compensation such as salary and bonus show little responsiveness to tax changes.

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We examine the relationship between wages and skill requirements in a sample of over 50,000 managers in 39 companies between 1986 and 1992. The data include an unusually good measure of job requirements and skills that can proxy for human capital. We find that wage inequality increased both within and between firms from 1986 and 1992. Higher returns to our measure of skill accounts for most of the increasing inequality within firms. At the same time, our measure of skill does not explain much of the cross-sectional variance in average wages between employers, and changes in returns to skill do not explain any of the time series increase in betweenfirm variance over time. Finally, we find only weak evidence of any declines in the rigidity of internal wage structures of large employers.

This paper develops a simple theory of pay structures and pay levels across heterogeneous agents by bringing together optimal contracts inside the firm and competitive resource allocation in the market. The central idea is that more talented people tend to create greater value but face larger conflicts of interest in their employment relationship, and different pay contracts are optimally designed to mitigate different levels of agency problems. Sorted by their talent, people are stratified into production workers, self-employed, salaried managers with low-powered performance pay, and CEOs with high-powered equity-based pay. In a general equilibrium framework, I show that the sorting of managerial talent into pay contracts is tied to firm size. The theory highlights that high-powered incentive pay and large scales of operations cause the disproportionately large wage earnings at the top, and are the main source of income inequality. Market forces that reallocate resources from smaller to larger firms tend to increase the threshold talent for becoming a manager, increase the prevalence of high-powered incentive pay, raise the top earnings, and spread out the wage distribution.

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This paper examines under what circumstances the market-based compensation scheme is effective in inducing managers ’ incentives. We combine the optimal contract theory with the market microstructure literature and endogenize both the optimal compensation scheme and the stock market equilibrium. We analytically show that the incentive pay works better in a more efficient (or more informative) stock market. Empirical tests justify our model prediction. Using residual analyst coverage as one proxy for market informativeness, we find that the coverage is negatively related to the compensation level and positively to the pay-for-performance sensitivity, suggesting that an efficient market induces managerial incentives as well as structures their behavior.

We extend the literature on the effects of managerial entrenchment to consider how safety-net subsidies and financial distress costs interact with managerial incentives to influence capital structure in U.S. commercial banking. Using cross-sectional data on publicly traded, highest-level U.S. bank holding companies, we find empirical evidence of Marcus ’ proposition (1984) that there are dichotomous strategies for value maximization—one involving relatively higher financial leverage and the other, lower financial leverage. We find that a less levered capital structure is associated with higher charter value and vice versa. Moreover, differences in charter value result in dichotomous strategies for managerial entrenchment: under-performing, less levered firms hold too little capital while under-performing, more levered firms hold too much.