Profit-Based Compensation and Corporate Tax Evasion

Abstract

This paper attempts to analyze corporate tax evasion in a principal-agent framework._x000D_ We assume that the firm’s profit is positively related to managerial effort and that_x000D_ the executive compensation is profit-based. In addition, we consider the situation_x000D_ where the manager might underreport the firm’s earnings to the shareholders or to_x000D_ the tax authorities and consume the unreported income as rent when the manager_x000D_ possesses private information regarding the firm’s earnings. We show that, under_x000D_ these considerations, the production decision and tax evasion decision are not_x000D_ separable; moreover, the profit taxes are not neutral.