The Taxation of Executive Compensation

Over the past 20 years, there has been a dramatic increase in the share of executive compensation paid through stock options. We examine the extent to which tax policy has inuenced the composition of executive compensation, and discuss the implications of rising stock-based pay for tax policy. We begin by describing the tax rules for executive pay in detail and analyzing how changes in various tax rates affect the tax advantages of stock options relative to salary and bonus. Our empirical analysis leads to three conclusions. First, there is little evidence that tax changes have played a major role in the dramatic explosion in executive stock-option pay since 1980. Although the tax advantage of options has approximately doubled since the early 1980s, options currently have only a slight tax advantage relative to cash—approximately $4 per $100