Executive Equity Compensation and Tax Avoidance: The Effect of Firm Size

Abstract

This study examines whether executive equity-based compensation provides incentives to engage in greater tax avoidance. Relying on agency and tax exhaustion theories, we posit that the relation between equity compensation and tax avoidance is more positive in smaller firms than in larger firms. Using a recently available compensation database, which includes a much broader universe of companies, we find that tax avoidance is increasing in equity incentives, but only in smaller firms. These results suggest that differences in firm size and the resulting implication for the association between equity compensation and tax avoidance at least partially explain why some empirical tests based on large-firm samples fail to corroborate economic theory. We provide the novel insight that size is a boundary condition that reconciles the seemingly conflicting agency and tax exhaustion theories with respect to the relation between equity compensation and tax avoidance.