A study on the incentive compensation structure with payroll tax: A continuous-time principal-agent model |
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| Institution: | 1. The School of Economics, Changzhou University, 213164 Wujin District, Changzhou, China;2. Business School, Chengdu University of Technology, 610059 Chenghua District, Chengdu, China;3. The School of Economic Mathematics, Southwestern University of Finance and Economics, 611130 WenJiang, Chengdu, China;1. School of Economics and Management, Shanxi University, Taiyuan, China;2. Department of Economics, Pusan National University, Busan, Republic of Korea;1. Shenzhen Central Sub-branch, The People’s Bank of China, Shenzhen, China;2. School of Finance, Nanjing University of Finance and Economics, Nanjing, China;3. Institute of Agricultural Economics and Development, Chinese Academy of Agricultural Sciences, Beijing, China |
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| Abstract: | This paper studies a case when the government levies a payroll tax on the employee (agent) of an enterprise. We use a continuous-time principal-agent framework to analyze the impact of the tax on the employee’s working strategy and derive an incentive compensation scheme. The agent is supposed to be aware of his pre-tax and after-tax salary. Under the theory of behavioral economics, loss caused by taxation is taken into consideration. The Hamilton-Jacobi-Bellman (HJB) equation of principal’s profits is derived. By exploiting the HJB equation, we get several properties of the optimal contract. We also perform comparative statics to show our results. The model suggests that the agent’s utility loss enlarges as the tax rate increases. However, an increase in the tax rate does not always decrease principal’s profits. |
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| Keywords: | Principal-agent model Payroll tax Incentive compensation Utility loss |
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