fairly extensive literature on incentives and financial misreporting, there is relatively little work
linking executives’ incentives with tax aggressiveness.5 Slemrod (2004) develops the idea that shareholders select the level
of tax aggressiveness by linking tax manager compensation with effective tax rates or stock price. However, one serious
limitation in this model is that shareholders cannot observe the compensation contract or know whether managers are
engaging in legal tax planning or illegal tax evasion. Thus, inappropriate aggressive behavior by the tax director constitutes
a ‘‘hidden action,’’ because tax returns are not disclosed to investors (see Crocker and Slemrod, 2005), and shareholders do
not know whether to alter the executive’s compensation contract until after the firm is penalized. In addition, it is difficult
to contract on tax evasion, since the behavior is illegal and therefore would render any contract that is a function of this
outcome unenforceable by the courts (Chen and Chu, 2005). Ultimately, Slemrod (2004) suggests that corporate tax
noncompliance (tax evasion) could be the result of the design of incentive compensation plans
fairly extensive literature on incentives and financial misreporting, there is relatively little work
linking executives’ incentives with tax aggressiveness.5 Slemrod (2004) develops the idea that shareholders select the level
of tax aggressiveness by linking tax manager compensation with effective tax rates or stock price. However, one serious
limitation in this model is that shareholders cannot observe the compensation contract or know whether managers are
engaging in legal tax planning or illegal tax evasion. Thus, inappropriate aggressive behavior by the tax director constitutes
a ‘‘hidden action,’’ because tax returns are not disclosed to investors (see Crocker and Slemrod, 2005), and shareholders do
not know whether to alter the executive’s compensation contract until after the firm is penalized. In addition, it is difficult
to contract on tax evasion, since the behavior is illegal and therefore would render any contract that is a function of this
outcome unenforceable by the courts (Chen and Chu, 2005). Ultimately, Slemrod (2004) suggests that corporate tax
noncompliance (tax evasion) could be the result of the design of incentive compensation plans
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