Explaining Firm Willingness to Forfeit Tax Deduction Under Internal Revenue Code Section 162(M): The Million-Dollar Cap

Abstract

We examine firms' willingness to forfeit tax deductions in response to Internal Revenue Code Section 162(m). Using a sample of firms over the five-year period subsequent to the effective date of Section 162(m), we find firms forfeit deductions in almost 40 percent of firm-year observations. Empirically, we find the decision to forfeit is consistent with firms trading off the costs and benefits of preserving deductions. In particular we find that firms with higher recontracting costs are more likely to forfeit deductions, while firms with higher tax benefits and political costs are more likely to fully preserve deductions. In documenting the willingness of corporations to forfeit deductions, we add to the body of evidence that suggests Section 162(m) is not totally successful in using tax policy to curb executive pay.

Keywords: IRC Section 162(m), executive compensation, tax deductibility, costs and benefits

JEL Classification: H25, J33, G38