This study investigates whether compensating chief executive officers and business‐unit managers using after‐tax accounting‐based performance measures leads to lower effective tax rates, the empirical surrogate used for tax‐planning effectiveness. Utilizing proprietary compensation data obtained in a survey of corporate executives, the relation between effective tax rates and after‐tax performance measures is modeled and estimated using a two‐step approach that corrects for the endogeneity bias associated with firms' decisions to compensate managers on a pre‐ versus after‐tax basis. The results are consistent with the hypothesis that compensating business‐unit managers, but not chief executive officers, on an after‐tax basis leads to lower effective tax rates.
