The Effects of a Bonus Tax on Manager Compensation and Welfare

This paper analyses the implications of a bonus tax for compensation components and firm profits, and studies its incidence as well as welfare implications. Using a principal-agent model with endogenous or exogenous reservation wages, we show how the effort-based compensation component changes in the country introducing the tax. Moreover, with exogenous reservation wages, the bonus tax negatively affects profits and dividends such that the incidence falls on the firm's shareholders. With endogenous reservation wages, the results are largely similar.