IRC Section 162(m) and the law of unintended consequences |
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Authors: | Kenneth R Ferris James S Wallace |
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Institution: | a W.P. Carey School of Business, Arizona State University, Phoenix, AZ, 85069-7100, United States b The Peter F. Drucker and Masatoshi Ito Graduate, School of Management, Claremont Graduate University, Claremont, CA, 91711-6160, United States |
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Abstract: | In 1993, Section 162(m) of the U.S. Internal Revenue Code was passed into law with the intent to reign in outsized executive compensation by eliminating the tax-deductibility of executive compensation above $1 million unless the excess compensation was performance-based. An unintended consequence of the legislation was that executives' total compensation actually increased in the post-1993 period, largely due to a dramatic increase in employee stock options. Employee stock options have unintended consequences of their own. The economic value of stock options may be influenced by executive decision-making when the options are valued using the Black-Scholes model or some variant thereof. Our findings suggests an unintended consequence that executives used their discretion to positively impact the performance-based component of their compensation through actions increasing share price volatility and reducing dividend yields, assumptions implicit in option valuation models. |
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Keywords: | Section 162(m) Employee stock option Unintended consequence Executive compensation Dividend yield Share price volatility |
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