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The Role of Managerial Ability in Corporate Tax Avoidance
Abstract
Most prior studies model tax avoidance as a function of firm-level characteristics and do not consider how individual executive characteristics affect tax avoidance. This paper investigates whether executives with superior ability to efficiently manage corporate resources engage in greater tax avoidance. Our results show that moving from the lower to upper quartile of managerial ability is associated with a 3.15% (2.50%) reduction in a firm’s one-year (five-year) cash effective tax rate. We examine how higher-ability managers reduce income tax payments and find that they engage in greater state tax planning activities, shift more income to foreign tax havens, make more research and development credit claims, and make greater investments in assets that generate accelerated depreciation deductions. Identifying a manager characteristic related to firms’ tax policy decisions adds to our understanding of the factors that explain the substantial variation in corporate income tax payments across firms.
This paper was accepted by Mary Barth, accounting.
... Second, our study extends the literature on managerial ability that investigates how highability management influences corporate decisions and firm financial policies. For example, the extant literature shows that managerial ability significantly affects earnings quality (Demerjian et al., 2013), corporate innovation (Cho et al., 2016), corporate tax avoidance (Koester et al., 2017), corporate investment (Andreou et al., 2017;Lee et al., 2018), income smoothing (Baik et al., 2020), the information environment (Baik et al., 2018) and mergers and acquisitions (Doukas and Zhang, 2021). There are a few studies that also focus on the implications of managerial ability for the capital market, including credit risk management Cornaggia et al., 2017), bank loan pricing (De Franco et al., 2017), and bank loan contracts (Bui et al., 2018). ...
... Subsequent studies exploit the managerial ability data of Demerjian et al. (2012) and document that managerial ability has a considerable influence on corporate outcomes (e.g., Cho et al., 2016;Demerjian et al., 2013;Koester et al., 2017). We expand this literature by investigating the role of managerial ability in influencing corporate debt choice. ...
... For example, Eisfeldt and Papanikolaou (2013) show that managers with more outside options (i.e., more able managers) have a disproportionate share of firms' cash flow, which increases shareholders' risk. Koester et al. (2017) find that firms with more able managers avoid corporate tax. Moreover, studies indicate that managerial ability is positively associated with over-investment behavior (Eisfeldt and Papanikolaou, 2013). ...
Using a sample of 54,964 firm-year observations of U.S. public firms during the period 2001 to 2020, we investigate how managerial ability affects corporate debt choice. We find evidence that managerial ability is negatively associated with the use of bank debt. This finding remains robust to a battery of robustness tests, including alternative measures of managerial ability and debt choice, various econometric specifications, and a range of endogeneity tests. Using the sudden death of the CEO as an exogenous shock to the managerial ability, our difference-in-differences regression suggests a negative causal relationship between managerial ability and reliance on bank debt. Further, using advanced machine learning models, we identify that managerial ability is one of the highly influential variables in predicting firms’ debt choices. Our cross-sectional tests indicate that this relationship is more pronounced in the presence of higher information opacity, weaker corporate governance and poor financial conditions. In additional tests, we show that firms with more able managers use more unsecured debt and public debt. Taken together, our findings suggest that managerial ability matters in shaping corporate debt choice.
... For example, firms have several foreign physical locations for their business operations, resulting in more opportunities for tax avoidance. In another way, firms may simply move their physical location to foreign countries for tax advantages (Koester et al. 2017). In practice, the former would be more common, or a firm may register a subsidiary in some tax havens but would not move its physical locations considering the high costs. ...
... In addition, we rule out the possibility that a firm's ability to avoid tax is just a reflection of managerial ability. We find that the pattern between managerial ability and tax avoidance (Koester et al. 2017) does not exist after controlling our measure of a firm's ability. This indicates that a firm's ability is more likely to be the prerequisite of tax avoidance compared to managerial ability. ...
... Before our paper, there is limited paper introducing the concept of a firm's ability to avoid taxes. Most papers focus on the managerial ability on tax avoidance (Koester et al. 2017;Khurana et al. 2018). Koester et al. (2017) assume that higher-ability executives have a better understanding of their firm's operating environment, enabling more alignment of tax strategies in business decisions. ...
This study examines the linguistic cues of tax avoidance in 10-K filings by constructing a tax-strategy-related (TSR) word list. We find a positive relationship between a firm's innate ability to avoid taxes, measured by the occurrence of TSR words, and the level of tax avoidance. Our results are robust across multiple measures and unaffected by firms' disclosure behavior or managerial ability. Additionally, investors negatively value the disclosure of TSR words in well-governed and less tax-avoiding firms.
... Since managerial ability cause heterogeneous firm responses and investments lead to varied levels of success in integrating environmental resources into practice (Hart, 1995;Sharma and Vredenburg, 1998;Cockburn et al., 2000;Sherer and Lee, 2002), we postulate that more able managers should be able to mitigate climate change concerns pre-emptively, resulting in decreased climate change exposure in earnings calls. We use the Demerjian et al. (2012) Data Envelopment Analysis (DEA) based managerial ability measure (Bonsall et al., 2017;Baik et al., 2020;Koester et al., 2017) and Sautner et al. (2023) earnings call-based climate change exposure to investigate how a manager's ability to efficiently manage a firm's resources affects the firm's exposure to climate change. ...
... Residuals found from this estimation is considered the managerial ability measure. This residual is attributed to the management team and is validated by a number of tests in Demerjian et al. (2012) and has been widely used in accounting (Koester et al., 2017;Baik et al., 2020;Demerjian et al., 2012Demerjian et al., , 2013 and finance literature (Albuquerque et al., 2013;De Franco et al., 2017;Bui et al., 2018;Doukas and Zhang, 2021). For a robustness check, we use an alternative measure for managerial ability: the MA Rank, which is essentially the decile rank (by industry and year) for the continuous Demirijian (2012) managerial ability score. ...
... We include both year and industry fixed effects to control for time-invariant industrial factors and time-varying unobservable factors. In addition, we include firm fixed effects to capture the average impact of unobservable time-invariant firm characteristics, consistent with previous research on managerial ability (Koester et al., 2017). If our hypothesized relationship holds, then we expect the coefficient β 1 to be negative. ...
Purpose
This study aims to investigate how a firm's management team's capacity to efficiently use its resources affects the firm's exposure to climate change. Specifically, the authors investigate the intriguing question – does managerial ability affect a firm's climate change exposure?
Design/methodology/approach
The authors use an unbalanced panel dataset of 4,230 US based firms listed on Compustat from 2002–2019 and test the hypothesis by panel regression analysis. To mitigate endogeneity concerns, difference-in-differences and instrumental variable approaches are used.
Findings
The baseline analysis shows a negative, statistically significant impact of managerial ability on climate change exposure. The findings hold after controlling for endogeneity using two-stage least squares regression and difference-in-differences tests. The authors find the negative effect is stronger for managers engaged in socially responsible activities, and after climate change issues receiving greater public awareness following the 2006 release of the Stern Review and the 2016 signing of the Paris Accord.
Research limitations/implications
Motivated by the resource-based theory and the natural resource-based view of the firm model, the empirical results support the view that greater managerial ability protects the firm against environmental challenges through efficient use of firm resources. Compared with traditional climate change measures that are plagued by disclosure issues, the use of the Sautner, Van Lent, Vilkov and Zhang's machine learning based dataset utilizing earning conference calls provides stronger, robust findings that will be useful to management and investors in environmental performance assessments.
Originality/value
Motivated by the resource-based theory and the natural resource-based view of the firm model, the empirical results support the view that greater managerial ability protects the firm against environmental challenges through efficient use of firm resources. Compared with traditional climate change measures that are plagued by disclosure issues, the use of the machine learning based dataset utilizing earning conference calls provides stronger, robust findings that will be useful to management and investors in environmental performance assessments.
... The results of this study are in line with Raya and Saragih's (2021) research that managerial ability affects positively tax avoidance and states that more capable managers are found to be associated with greater tax avoidance because they have a better understanding of the business, environment, and opportunities that the company has so that these conditions allow managers to carry out more effective tax avoidance strategies. In addition, this study is also in line with research conducted by Koester et al. (2017), who found consistent evidence regarding higher-ability managers engaging in more tax avoidance activities that reduce their company's cash tax payments. This happens to managers with high abilities who have a better understanding of their company's operating environment allowing them to better align business decisions with tax strategies and identify tax planning opportunities. ...
... The results of this test are by Shareholder Theory which claims that company managers have the primary responsibility to maximize returns, and protect, and grow assets for the benefit of shareholders. Koester et al. (2017) in their research explained that cash tax payments do not generate company-specific returns, cash tax savings can be allocated to company operations with the potential to generate positive investment returns. This is in line with the test results that the higher the managerial ability of a company, the higher its chances of utilizing investment and conducting tax aggressiveness. ...
This research was conducted with two objectives, namely to test whether managerial ability can affect corporate tax aggressiveness, and to examine the role of investment opportunities as a moderating variable on the effect of managerial ability and tax aggressiveness. The sample used includes 129 manufacturing companies listed on the Indonesia Stock Exchange during the 2018-2022 period. This study used regression analysis using STATA 18. Managerial ability in this study was measured using the Data Envelopment Analysis (DEA) approach, tax aggressiveness was measured by the Book Tax Differences (BTD) approach and investment opportunities were measured by market to book and capital expenditure. The results of the study found that managerial ability had a positive effect on tax aggressiveness and investment opportunities strengthened the influence between the two. This research contributes to see how investment opportunities moderate and affect managerial ability towards tax aggressiveness. This will be useful for investors where they can view company reports and can be used to show market perceptions of the value of certain shares. There is also where this research contributes so that companies that prepare financial reports can present quality reports and avoid fraud. It also affects investors so that they can read financial reports clearly and use them to show market perceptions of the value of certain shares
... Managerial ability is increasingly recognized as an important worldwide determinant of several accounting practices. Recently, a considerable amount of literature tried to link managerial ability and earnings quality, earnings persistence, income smoothing, accounting conservatism, or tax avoidance (e.g., Demerjian et. al.,2013;Koester et. al., 2017;García-Meca & García-Sánchez,2018;Demerjian et. al., 2020;Haider et al.,2021). Earnings management is also recognized as one of the most important topics in accounting research. A considerable amount of literature has been published on earnings management; these studies did not settle the existing debate about the determinants of earning ...
... provide more accurate management earnings forecasts (Baik et. al.,2018), they focus on not only financial performance but also on nonfinancial performance elevating corporate social responsibility performance (Gong et, al., 2021), they demonstrate lower levels of opportunistic behavior as they are less likely to engage in tax avoidance activities (Koester et. al., 2017). Additionally, firms with less-able managers experience significant negative stock returns (Hayes & Schaefer, 1999), while firms with more-able mangers receive higher credit ratings (Bonsall et. al., 2017). From auditing point of view, a negative association was found between managerial ability and both audit fees and going-concern opin ...
... A subset of extant research examines whether or not management incentives determine the tax avoidance activities of the firm (Armstrong et al. 2012;Gaertner 2014;Phillips 2003;Rego and Wilson 2012), while others investigate various firm-specific determinants of corporate tax avoidance (Dyreng et al. 2013;Hasan et al. 2021aHasan et al. , 2021bLisowsky 2010;Markle and Shackelford 2011). Another stream of research examines whether or not ownership structure (Badertscher et al. 2013;Chen et al. 2010;Cheng et al. 2012;Gaertner 2014;Khan et al. 2017), governance, and executive characteristics (Armstrong et al. 2015;Bauer 2016;Desai et al. 2007;Dyreng et al. 2010;Koester et al. 2017;Law and Mills 2017) affect tax avoidance. In an important study, Higgins et al. (2015) find that prospector-strategy firms appear to take more aggressive and less sustainable tax positions than defenderstrategy firms. ...
We examine the association between strategic deviation—defined as the deviation of firms’ resource allocation from that of industry peers—and corporate tax avoidance. By combining the agency perspective with the risk aspect, we argue that managers of firms with high strategic deviation avoid tax compared with those of firms with low strategic deviation. High-strategic-deviant firms who avoid tax are likely to face the risk of compromising firm value. Based on a large sample of 40,168 US firm-year observations for the period 1987–2020, we find evidence supporting our hypothesis. A series of robustness tests validates our main finding. We further provide evidence to suggest that the positive association between strategic deviation and tax avoidance is stronger for deviant firms with high financial constraints, low institutional ownership, firms operating in more competitive markets, and procuring higher auditor provided tax services from incumbent auditors. Importantly, we show that the capital market penalises tax avoidance strategies undertaken by the deviant firms.
... Specifically, Cash_ETR is measured as the cash tax paid (txpd) divided by the pretax book income before special items (pi-spi). We use Cash_ETR as the primary measure of tax avoidance in our study because it captures both permanent and temporary tax deferral strategies (Koester et al., 2017). Our second effective tax rate is the GAAP effective tax rate (GAAP_ETR), which is defined as the income tax expense (txt) divided by the pretax book income before special items (pi-spi) (Graham et al., 2014(Graham et al., , 2017. ...
We examine whether improved cross‐border regulatory cooperation and information exchange affect corporate tax avoidance. We find that the improvement in the regulators’ capacity to access to information in foreign countries through their entrance into the Multilateral Memorandum of Understanding (MMoU) effectively reduces corporate tax avoidance. Moreover, the effect of the MMoU on corporate tax avoidance is stronger for firms that are less income mobile and have no significant subsidiaries in tax havens. Collectively, these findings support the conjecture that the strengthened cross‐border regulatory cooperation and information exchange provided by the MMoU creates a positive externality in reducing corporate tax avoidance behavior.
... The study utilized a set of control variables, which were based on firm tax behavior and its correlated factors. In particular, the control variables that were included in the analysis were those that are related to tax avoidance behavior, such as SIZE, ROA, and R&DEXP, which were consistent with previous studies by Dyreng et al. (2010) and Koester et al. (2016). SIZE, as the natural logarithm of total assets; ROA, as the ratio of net income to total assets; and R&DEXP, as the research and development expense. ...
The objective of this research is to examine the potential impact of CEO age on the involvement of companies in tax amnesty programs among publicly traded companies in Indonesia. With differing opinions on how age affects risk-taking behavior, this study attempts to clarify the issue. The researchers gathered and examined 210 firm-year records to create the main dataset for analysis. To investigate the relationship between CEO age and tax amnesty participation, statistical approaches such as correlation, logistic regression analysis, and propensity score matching (PSM) were utilized as analytical tools. The results show a negative association between the age of the CEO and their readiness to participate in tax amnesty, indicating that older CEOs may view tax amnesty as a dangerous endeavor and be less inclined to take part. This negative association was further supported by an additional analysis of two tax amnesty programs, one from 2016 and the other from 2017. It showed that older CEOs tended to behave in a more risk-averse manner. Because of the possible risks, they are therefore less likely to take part in tax amnesty initiatives. Overall, this study advances knowledge on how CEO age affects business decision-making and sheds light on the factors influencing tax amnesty program participation.
... Successful organizations are managed by executive directors with differentiated management skills in strategic decisions, risk, processes and leadership (Moura et al., 2019). Furthermore, more skilled managers do not tend to engage in tax evasion activities (Francis et al., 2013;Koester, Shevlin & Wangerin, 2017), a factor that can harm an organization's financial health in the long term. ...
O objetivo do estudo é analisar a influência do compliance às boas práticas de governança corporativa na escolha de gestores com habilidade gerencial. A amostra investigada considerou 498 observações no período de 2015 a 2019, das 100 empresas listadas na B3 como maior liquidez das ações, utilizando-se o método de regressão linear múltipla para análise. Os resultados evidenciam que as empresas com práticas deficientes de governança corporativa e com menor atendimento aos requisitos dos referenciais de boas práticas de governança corporativa atuam com gestores mais habilidosos para compensar a deficiência organizacional. As evidências indicaram que empresas com maior compliance às boas práticas de governança corporativa possuem gestores que não apresentam, necessariamente, maior habilidade gerencial. Os achados indicam que as empresas com compliance às boas práticas de governança corporativa conseguem estabelecer elevados padrões de cultura organizacional, reduzindo a dependência da habilidade gerencial do gestor sobre os resultados da organização.
... Hence, the amount of expense, income and company's losses or profit received becomes more certain. Certainty of losses or profits tends to make managers less aggressive to do tax avoidance (Koester et al., 2017;Park et al., 2016). ...
Taxes play an essential role in state funding. As something that is not profitable for the company, it usually encourages efforts to reduce taxes by doing a tax avoidance. This study aims to determine the effect of environmental uncertainty on tax avoidance and to determine the managerial ability to weaken the effect of environmental uncertainty on tax avoidance. Using SPSS, 458 samples used in this study are manufacturing companies listed on the Indonesia Stock Exchange in the period 2016 – 2020. The results of this study indicate that environmental uncertainty affects tax avoidance and managerial ability strengthens the effect of environmental uncertainty on tax avoidance. This result may be due to the large influence of environmental uncertainty in the company so that the risks obtained are difficult for managers to overcome.
... Even though it is not a requirement for a director to manage a company to be educated in economics and business, if they have an educational background in economics and business, the board of directors is expected to be able to manage the company and make decisions that can benefit the company. Directors who are educated in economics and business will make tax savings through tax avoidance which can provide benefits to shareholders without violating tax regulations ( The ability of the board of directors greatly influences company tax management (Koester et al., 2016). Directors who have financial expertise will develop business strategies that can save the company's burdens, one of which is the tax burden. ...
... For example, variation in governance characteristics is associated with management quality (Koester, Shevlin, and Wangerin 2017), business environments with different tax avoidance opportunities (Higgins, Omer, and Phillips 2015), stronger internal information quality (Gallemore and Labro 2015), and increased shareholder expectations for the board of directors (Beasley et al. 2008). Power (2009) proposes that ERM is often implemented as a promise to fix past mistakes, with Eckles et al. (2014) finding that ERM-adopting firms report higher firm-risk before adoption. ...
Tax aggressiveness presents nontax risks to firms’ cash flow. Evaluating these risks requires information beyond the accounting function’s expertise, resulting in high processing costs to acquire and integrate risk information relevant to tax strategies. Managers can rationally adapt by making assumptions about risk information, potentially resulting in decision biases when evaluating the risk-reward tradeoff of tax aggressiveness. Using a novel regulatory setting in the U.S. insurance industry, I examine whether the adoption of mandated enterprise risk assessments updates managers’ prior beliefs about the nontax risks of tax aggressiveness. I find that as regulation requires managers to accept processing costs to acquire and integrate risk information, managers learn about previously underestimated nontax risks and significantly reduce tax aggressiveness. Results suggest that absent firm-wide internal risk information, managers can use aggressive tax positions without fully considering nontax risks.
Data Availability: Data used in this study are available from public sources identified in the paper.
JEL Classifications: G22; G32; H25; M41.
... Meanwhile, at this stage, the benefit pursuit effect is very limited. To improve performance by avoiding tax, firms need to identify and exploit tax planning opportunities effectively (Koester et al., 2017). Yet, big performance success indicates the superiority of current strategies (Kim et al., 2009;Ref & Shapira, 2017), which also include tax strategies. ...
This study provides a new behavioral explanation of corporate tax avoidance. Drawing on tax avoidance research and the insights from performance feedback literature, we identify performance above aspiration as an important antecedent of corporate tax avoidance. We also explore the contingency effect of CEO experience since it may influence how the CEO views performance above aspiration and implement tax avoidance decisions. This study considers two main aspects of CEO experience: CEO tenure (firm experience) and CEO financial experience (functional experience). Using a panel sample of Chinese listed companies from 2009 to 2018, we find that as performance rises above aspiration, firms increase tax avoidance at first, but, from a certain point onwards, they reduce such activities. We also find that this inverted U-shaped relationship is weakened by CEO tenure but strengthened by CEO financial experience.
... Third, the study builds on and extends research on the effect of managerial characteristics in determining firms' taxation behavior. Many prior studies identify various managerial elements affecting corporate taxation, such as manager ability, tenure, compensation incentives, and tax expertise (Dyreng, Hanlon, & Maydew, 2010;Koester, Shevlin, & Wangerin, 2017;Kubick, Li, & Robinson, 2020;Powers, Robinson, & Stomberg, 2016). This study suggests that culture can reflect an unobserved trait of management (i.e., opportunistic tendency and risk appetite), which echoes other studies on the impact of informal institutions on corporate tax avoidance. ...
... Based on the agency problem framework, the management tends to maximize their interests by utilizing their managerial abilities, which one of the ways is by conducting aggressive tax avoidance (Desai & Dharmapala, 2006;Koester et al., 2017, Lanis & Richardson, 2011. Tax aggressiveness can be defined as an effort to reduce taxable income in the form of tax planning (Lanis & Richardson, 2011). ...
This research examines the effect of diversification strategy on corporate tax aggressiveness activities with board effectiveness as the moderating variable. This study brings a context of the ASEAN Economic Community (AEC), which is argued inducing diversification strategies taken by companies in ASEAN countries. A sample from a developing country, that is, Indonesia, is collected due to this country’s specific characteristics related to tax regimes. Therefore, 246 observations from non-financial listed companies from 2014 to 2016 are used. The findings show that the firms with an international diversification strategy positively associate with corporate tax aggressiveness. On the other hand, companies conducting industrial diversification strategies were found to have ineffective tax management. The study also found an ineffective board of commissioners in the condition of corporate tax aggressiveness and ineffective tax management. This study brings some practical implications that the government needs to evaluate its tax policy while business practitioners must choose a business strategy congruent with tax management.
... Their results suggested that there was a strong and positive relationship between managerial ability and a firm's credit risk assessment. Koester et al. (2017) examined the relationship between high ability executives and corporate tax avoidance. Their findings showed that when compared to low-ability managers, high-ability managers were more involved in reducing income tax payments. ...
The purpose of this study to investigate the association between firm’s managerial ability and its issued credit rating. Twelve companies of USA oil and gas sectors have been selected on the basis of different work streams. A two stage derived model of data envelopment analysis and Tobit model is used for the measurement of firm’s managerial ability in this paper. For data envelopment analysis, cost of goods sold, fixed assets, general and administration expenses and intangible assets are used as input variable and operating revenue is used as output variable. To retain residual as firm’s managerial ability, Tobit model is estimated by using firm size, stock returns, leverage, operating cash flows and firm age as variables. The value of correlation test between credit ratings and firm’s managerial ability is 0.163 which indicates that there is positive linear relationship, which indicates that that firm’s managerial ability and credit rating is associated with each other and if managerial ability is increased by 100%, credit rating also increase by 16.3% . The relationship between managerial ability and credit rating significant and positive for USA oil and gas sector over the period from 2006 to 2020. While regression analysis for all oil and gas companies of USA indicates that 2.7% changes in credit rating occurred due to managerial ability, over all model is also significant. By enhancing the managerial ability of firm leads toward higher credit rating and consequently less cost of debt for their debt instruments
This paper analyses the influence of tax behavior on investment behavior of corporate managers in Benin. The paper applies the generalized method of moments (GMM) to dynamic panel data. The sample used covers 21 firms, i.e. 11 banks for the period from 2011 to 2020 and 10 DFSs for the period from 2016 to 2021. It is found that investment behavior is most positively affected by the tax saving due to the deduction of depreciation allowances on economic assets (EIDDAAE), then by corporate income tax (CIT) and finally by debt (DEBT); and negatively by equity (EQUITY) and past investment (INVESTMENT(-1)). This paper is one of the first to extend the literature by determining the influence of tax behavior on the investment behavior of corporate managers in Benin.
Purpose
This paper examines the moderating effect of good corporate governance on the association between internal information quality and tax savings.
Design/methodology/approach
This study uses a quantitative approach. It employs an Australian sample of analysis composed of 1,295 firm-year observations from the period 2017 to 2021. Data relating to corporate governance are hand-collected from the annual reports.
Findings
Based on the result of the analysis, this study demonstrates that the interaction between corporate governance and quality of internal information is positively associated with tax savings. Superior corporate governance is critical in activating the effect of internal information quality on tax savings. This finding is robust to a battery of robustness checks and additional tests.
Research limitations/implications
This examination utilizes only publicly traded companies from one developed country.
Practical implications
For the company management, an effective governance structure must be at the top because it will determine the development of all other areas. This study emphasizes the need to continuously improve the effectiveness of corporate governance practices. For long-term investors, an important indicator that can be considered in assessing the “safety” of a company’s tax strategy is its corporate governance aspects. For regulators, this study is expected to assist regulators in creating a more adequate corporate governance implementation and disclosure package to be implemented by corporations in the future.
Originality/value
This study provides new evidence on a crucial construct that can strengthen the relationship between internal information quality and tax savings.
This study examines the association between dispersion in pay‐performance sensitivities (PPS) among top management team (TMT) members and managerial efficiency. While prior research has focused on managerial efficiency as an innate characteristic of managers, this study explores how managerial incentive dispersion shapes managerial efficiency. Using a sample of US firms from 1993 to 2019, we find a negative relationship between TMT incentive dispersion and managerial efficiency, suggesting that higher levels of incentive dispersion can potentially affect managerial efficiency by reducing coordination and cooperation among TMT members. We employ a range of robustness tests and find consistent and robust results. Overall, this study contributes to the literature on executive compensation by providing novel insights into the implications of incentive dispersion among executives for managerial efficiency.
The chapter provides an in-depth exploration of the theoretical underpinnings of tax avoidance, shedding light on its distinct nature compared to tax evasion and the challenges surrounding its definition. It delves into the measurement methodologies employed to quantify tax avoidance and examines the factors that drive its occurrence. Furthermore, the chapter investigates the far-reaching economic consequences of tax avoidance, specifically focusing on its impact on corporate transparency, cost of capital, and firm value.
Based on stakeholder theory, resource-based theory, and decision theory, this study explores the relationship between information technology governance and internal information quality in determining business entity tax savings. Specifically, we examine the effects of internal information quality and information technology governance on corporate tax savings. We also investigate the joint effect of information technology governance and internal information quality on tax savings. This study used a quantitative method with panel data regression using a sample of the top 500 listed companies on the Australian Stock Exchange (ASX) from 2017 to 2021. Our dataset consists of 1,295 firm-year observations. We collected data manually to assess the proxy for information technology governance. Our analysis yielded three main findings. Firstly, we found no significant effect of the quality of internal information on tax savings on the ASX. However, we did observe a positive relationship between the construct of information technology governance and tax savings. Additionally, the presence of information technology governance was found to moderate this relationship. These findings remained consistent when subjected to various robustness checks and additional tests. Our findings highlight the importance of the information technology governance construct as a powerful catalyst for activating the link between internal information quality and optimal tax performance. This study has theoretical and practical implications for businesses, regulators, investors, and tax authorities, which are discussed further.
We investigate how tax avoidance affects the maturity structure of debt in firms where tax avoidance costs are presumably low, namely SMEs. Previous research has shown that creditors of listed tax-avoiding companies impose shorter maturities to more frequently reassess the tax avoidance risks in debt contracts. Using a sample of 110,690 firm-year observations of Spanish SMEs over the period 2007-2020, we examine the relationship between tax avoidance and debt maturity and the channels driving this relationship. We find that tax-avoiding SMEs show a longer debt maturity. This effect is stronger for SMEs with higher profitability, lower earnings management incentives, and higher reliability of financial reporting. We also find that tax avoidance reduces leverage and short-term debt, increases future cash flows, and decreases future cash flow volatility. Overall, these findings suggest that, unlike large firms, SMEs use cash tax savings to reduce leverage and short-term debt in their financial structure and that tax avoidance is positively valued by their lenders.
This study examines the relationship between stock return volatility (SRV) and financial distress (FD) and the moderating roles of ownership structure, managerial (CEO) ability, and financial constraints in this nexus. Using a panel sample of Vietnamese-listed companies from 2010-2020, we find that firms experiencing high SRV encounter more FD. Our finding is robust to alternative measures of both SRV and FD variables. Large-cap and low-leverage firms bear less FD risk owing to excessive stock return volatility than small-cap and high-leverage companies. Additional analyses reveal that the presence of state ownership mitigates FD likelihood while the presence of institutional and concentrated ownership exacerbates FD probability when heightened SRV. Further, an adverse impact of SRV on the firm's stability is more pronounced in companies with strong CEO power and less financial constraints. This research provides deep insights for corporate executives and policy-makers on the relationship between SRV and FD. Furthermore, it underscores the necessity of managing stock return volatility to ensure the stability of listed firms in emerging markets.
Our study examines changes in corporate cash tax savings around the disclosure of tax‐related key audit matters (tax KAMs). We expect publicly disclosed tax KAMs to increase the visibility of a firm's tax complexity and uncertainty, thereby motivating the firm to improve its tax function. In turn, we expect to observe increased cash tax savings as an outcome of improvements to corporate tax functions. As predicted, we document that firms exhibit lower cash effective tax rates in the period after their auditors disclose tax KAMs. Additional tests suggest that disclosure of tax KAMs does not increase the likelihood of firms being aggressive in cash tax planning and increased cash tax savings are primarily driven by firms that adjust toward their optimal levels of cash tax savings. Cross‐sectional analyses support our expectation that post‐disclosure increases in cash tax savings are less pronounced when investors were better informed about firms’ tax strategies in the pre‐disclosure period and when firms faced stronger tax enforcement in the pre‐disclosure period. Collectively, our results highlight the role of KAM disclosure requirements in prompting firms to improve their internal operational decisions.
Whether firms in transition economies undertake corporate social responsibility (CSR) is an important research topic in business ethics. Applying the middle-status conformity perspective, this study uses listed companies in the transition economy of China from 2010 to 2020 to assess the influence of social status on CSR conformity. The empirical findings revealed an inverted U-shaped relationship between social status and CSR conformity. That is, firms with low- or high-level status were less inclined to adopt CSR practices than the firms with a more middling status. Moreover, performance expectation gaps strengthened, while managerial ability flattened, the aforementioned inverted U-shaped relationship. This study sheds new light on the complicated motives for firms in transition economies to adopt CSR practices and further substantiates the boundary conditions of the curvilinear relationship between social status and CSR conformity.
Synopsis
The research problem
This study examines the impact of chief executive officers (CEOs)’ early-life disaster experiences on corporate tax-avoidance behaviors and explores the mechanisms through which these experiences influence these behaviors. We use the Great Chinese Famine of 1959–1961 (hereafter the Great Famine) as an indicator of early-life disaster experience.
Motivation or theoretical reasoning
Our study is motivated by the following reasons. First, like many major economies worldwide, corporate income tax is an important source of tax revenue in China. The financial impact of corporate income tax on a country’s economy is enormous. Second, the Great Famine was one of the most destructive natural disasters in human history, which is likely to have a lifelong influence on CEOs who lived through the disaster as children and teenagers. Third, corporate tax strategy is a significant accounting, financing, and managerial behavior of firms that is influenced by multiple internal and external factors. However, there are limited findings on the impact of CEOs’ early-life disaster experience on corporate tax decisions. The consequences of this impact remain unclear.
The test hypotheses
We hypothesize that CEOs’ early-life famine experience mitigates corporate tax aggressiveness. We also consider the alternative hypothesis that CEOs’ early-life famine experience increases corporate tax aggressiveness.
Target population
Our sample includes Chinese listed firms from 2013 to 2020 led by CEOs who have or who do not have early-life disaster experiences.
Adopted methodology
We employed ordinary least square regressions in our analyses.
Analyses
Since the Great Famine occurred between 1959 and 1961, we considered CEOs to have experienced famine if they were born prior to or in the year 1961, in a province affected by the Great Famine (e.g., Hu et al. , 2020 ; Zhang , 2017 ). We identified a province as significantly affected by famine if its abnormal death rate was greater than the median abnormal death ratio of all Chinese provinces during the period of famine. Following Dyreng et al. ( 2010 ), Hoi et al. ( 2013 ), Koester et al. ( 2017 ), and Rego & Wilson ( 2012 ), we used effective tax rate as the first proxy of tax avoidance for a firm. Additionally, in line with Desai & Dharmapala ( 2006 ) and Hoi et al. ( 2013 ), we used the discretionary book-tax differences of firms as an alternative proxy to measure corporate tax avoidance.
Findings
The findings indicate that CEOs who experienced the Great Famine at a young age significantly reduced their firms’ tax-avoidance efforts. Furthermore, the negative association between CEOs’ early-life famine experiences and corporate tax-avoidance behaviors is more pronounced for companies with higher independent director ratios. These negative associations appear more obvious for firms with CEOs who experienced famine early in life and for females. The economic mechanism of the findings demonstrate that CEOs’ famine experiences make them more conservative in investing in innovative projects; they are more likely to fulfill corporate social responsibility and work in state-owned enterprises. Furthermore, firms with lower innovation expenditure, effective corporate social performance, and government ownership are less likely to display tax-avoidance behaviors.
High-tech small- and medium-sized enterprises (SMEs) need to innovate and invest in research and development (R&D) activities to remain competitive. However, due to their liability of smallness, the returns from R&D in terms of financial performance may be not as expected in such firms. Combining the resource management perspective with managerial ability research, we elaborate upon how managerial ability influences the effect of R&D on the financial performance of high-tech SMEs. We also investigate how this moderation is affected by the external environment in which high-tech SMEs operate. Using a moderated moderating model and the panel data of 256 Chinese high-tech SMEs from 2007 to 2019, we find that managerial ability strengthens the impact of R&D on the financial performance of high-tech SMEs. This moderating effect is more pronounced during the economic downturn and in regions with better digital economy development. Our findings provide important implications for high-tech SMEs on their R&D strategies and human capital management as well as the government.
This research was conducted with the aim of examining the effect of business strategy on environmental disclosure moderated by the managerial ability of the CEO. The research data was obtained from the CDP (Carbon Disclosure Project) data center between 2015-2021, with a total of 1243 company-year observations. Hypothesis testing was conducted using the Moderated Regression Analyses (MRA) method with fixed effects of country, industry, and year. This study found that business strategy generally has a negative effect on environmental disclosure. Specifically, the researcher found that mining-type strategies have a negative effect on environmental disclosure, while defender-type strategies have a positive effect on environmental disclosure. Furthermore, the CEO's managerial ability moderates the effect of mining and defender-type strategies on environmental disclosure. In a more comprehensive manner, this study also conducted robustness and endogeneity testing to improve the testing results. This study provides both theoretical and practical contributions to the development of the literature in the field of corporate governance.
Keywords: Business Strategy; Environmental Disclosure; CEO Managerial Ablity; Typology; Governance
Using a sample of Chinese A‐share listed firms over the period 2010–2017, this paper investigates the impact of local donation culture on corporate tax avoidance. We find that firms located in areas with a strong local donation culture are less engaged in tax avoidance. The results remain robust under a variety of robustness tests. Furthermore, we find that this relationship is driven by enhancing the moral identity of managers. In further analysis, we also explore the role of media attention, chief executive officer's (CEO's) childhood famine experience, and CEO duality in the relationship between local donation culture and corporate tax avoidance. This study enriches the existing literature on culture and firms' behaviors, and the conclusion of this paper has significant policy implications for governing corporate tax avoidance.
As interim CEO appointments are common in CEO successions, we examine these temporary executives’ economic impact on their firms. Specifically, we explore how interim CEOs affect corporate tax avoidance. We match each “interim CEO firm” (test firms) with a “direct-succession CEO firm” (control firms) and find that test firms report significantly and economically lower tax avoidance. We also find that test firms’ pre-tax earnings are similar to those of control firms, but their after-tax earnings are significantly lower. Further, we find that this lower tax avoidance holds only when interim appointees have low equity compensation, are not named as permanent/successor CEOs, and have no CFO background. Our paper opens the door for future investigation of the economic impact of interim CEOs, which has been under-investigated by prior studies.
Purpose
Research on the organizational ramifications of chief executive officer (CEO) greed remains scarce. This study intends to fill this gap by examining the impact of CEO greed on an important yet risky corporate strategy, corporate tax avoidance (CTA). Drawing on upper echelons theory, the authors argue that greedier CEOs tend to engage in more CTA. The relationship is weaker when CEOs experienced economic recessions in their early career and stronger when CEOs are endowed with equity ownership of their respective firms.
Design/methodology/approach
The authors test the hypotheses with data from US public firms from 1997 to 2008 and employ the ordinary least square regression analysis to analyze the hypothesized relationships. The authors also test the robustness of the results by performing the two-stage least square regression and propensity score matching analyses.
Findings
The findings lend broad support to all the hypotheses. The authors find that greedier CEOs tend to engage in more CTA by paying lower corporate taxes. The impact of greed on CTA is attenuated when CEOs are recession CEOs and is exacerbated when CEOs own large numbers of firm shares.
Originality/value
This paper contributes to the upper echelons research by investigating a novel executive personal characteristic, greed, and its negative impact on an important organizational outcome. This paper also contributes to the growing tax research that recognizes the important role executives play in shaping corporate tax strategies.
Prior work on earnings smoothing is mixed and has characterized smoothing as both beneficial (e.g., Subramanyam 1996; Tucker and Zarowin 2006; Badertscher, Collins, and Lys 2012) and detrimental (e.g., Levitt 1998; Leuz, Nanda, and Wysocki 2003). We hypothesize that one reason for these mixed results is differential ability across managers in their capacity to effectively smooth. Thus, we investigate whether higher-quality managers are more likely to undertake earnings management mechanisms to artificially smooth earnings, and if so, whether the costs to smoothing are lower for these managers. We find that although sales are more volatile, earnings are smoother in firm-years led by the best managers relative to firm-years led by less able managers, and the smoother earnings are achieved, at least partially, using reporting discretion. Further, the costs of smoothing earnings are lower in firm-years lead by a high-ability manager. To provide more evidence on whether this smoothing is better characterized as good or evil we explore whether it is associated with firm-level incentives or executive-level incentives, and whether or not it is constrained by governance. We conclude that the best managers artificially smooth earnings to benefit shareholders, as the smoothing is associated with firm-level incentives and is not constrained by governance; in contrast, artificial smoothing among the worst managers is not associated with firm-level incentives to smooth and is constrained by corporate governance. Our findings provide insights into the mixed evidence on earnings smoothing, suggesting that it is context-specific and earnings smoothing undertaken by the best managers benefits shareholders.
This article examines whether managers impact firm performance. We conservatively define managerial ability as the manager's capacity to deploy the firm's resources. We verify the validity of our metric using a manager–firm matched panel data set that allows us to track managers (CEOs) across different firms over time. We find managerial ability is inversely related to the amount of time a firm spends in distress, the likelihood of a firm's failure, and the cost of failure. These results suggest that the managers of failed firms are less skilled than their counterparts. But even within failed firms there is heterogeneity in the talents of managers.
We analyze survey responses from nearly 600 corporate tax executives to investigate firms' incentives and disincentives for tax planning. While many researchers hypothesize that reputational concerns affect the degree to which managers engage in tax planning, this hypothesis is difficult to test with archival data. Our survey allows us to investigate reputational influences and, indeed, we find that reputational concerns are important—69 percent of executives rate reputation as important and the factor ranks second in order of importance among all factors explaining why firms do not adopt a potential tax planning strategy. We also find that financial accounting incentives play a role. For example, 84 percent of publicly traded firms respond that top management at their company cares at least as much about the GAAP ETR as they do about cash taxes paid and 57 percent of public firms say that increasing earnings per share is an important outcome from a tax planning strategy.
JEL Classifications: D83; G31, M41.
Data Availability: Survey responses are confidential. Other data are available from public sources identified in the paper.
Empirical research on pioneering advantage establishes a strong association between pioneering and market share. Researchers, however, suggest that managerial skills may account for the relationship and underscore the need to control for such skills. The authors develop efficiency measures to represent a firm's managerial skills, employing the data envelopment analysis framework as well as a regression-based approach. Furthermore, they account for unobserved, firm-specific factors that include unobserved managerial skills. With such systematic control for observed and unobserved managerial skills, they reexamine the impact of pioneering on market share and find that it is robust even after they control for managerial skills.
Presented are new failure-prediction models for detecting a bank's troubled status up to two years prior to insolvency using publicly available data and a new category of explanatory variable to capture the elusive, yet crucial, element of institutional success: management quality. Quality is assessed using data envelopment analysis (DEA), which views a bank as transforming multiple inputs into multiple outputs, focusing on the pri-mary functions of attracting deposits and making loans. The new models are robust and accurate, as veri ed by in-depth empirical evaluations, cost sensitivity analyses, and comparisons with other published approaches.
We build on an emerging strategy literature that views the firm as a bundle of resources and capabilities, and examine conditions that contribute to the realization of sustainable economic rents. Because of (1) resource-market imperfections and (2) discretionary managerial decisions about resource development and deployment, we expect firms to differ (in and out of equilibrium) in the resources and capabilities they control. This asymmetry in turn can be a source of sustainable economic rent. The paper focuses on the linkages between the industry analysis framework, the resource-based view of the firm, behavioral decision biases and organizational implementation issues. It connects the concept of Strategic Industry Factors at the market level with the notion of Strategic Assets at the firm level. Organizational rent is shown to stem from imperfect and discretionary decisions to develop and deploy selected resources and capabilities, made by boundedly rational managers facing high uncertainty, complexity, and intrafirm conflict.
We develop and describe a new measure of long-run corporate tax avoidance that is based on the ability to pay a low amount of cash taxes per dollar of pre-tax earnings over long time periods. We label this measure the long-run cash effective tax rate. We use the long-run cash effective tax rate to examine 1) the extent to which some firms are able to avoid taxes over periods as long as ten years, and 2) how predictive one-year tax rates are for long-run tax avoidance. In our sample of 2,077 firms, we find there is considerable cross-sectional variation in tax avoidance. For example, approximately one-fourth of our sample firms are able to maintain long-run cash effective tax rates below 20 percent, compared to a sample mean tax rate of approximately 30 percent. We also find that annual cash effective tax rates are not very good predictors of long-run cash effective tax rates and thus, are not accurate proxies for long-run tax avoidance. While there is some evidence of persistence in annual cash effective tax rates, the persistence is asymmetric. Low annual cash effective tax rates are more persistent than are high annual cash effective tax rates. An initial examination of characteristics of firms successful at keeping their cash effective tax rates low over long periods shows that they are well spread across industries but with some clustering.
We examine the relation between managerial ability and earnings quality. We find that earnings quality is positively associated with managerial ability. Specifically, more able managers are associated with fewer subsequent restatements, higher earnings and accruals persistence, lower errors in the bad debt provision, and higher quality accrual estimations. The results are consistent with the premise that managers can and do impact the quality of the judgments and estimates used to form earnings.
Data Availability: Data are publicly available from the sources identified in the text.
We propose a measure of managerial ability, based on managers' efficiency in generating revenues, which is available for a large sample of firms and outperforms existing ability measures. We find that our measure is strongly associated with manager fixed effects and that the stock price reactions to chief executive officer (CEO) turnovers are positive (negative) when we assess the outgoing CEO as low (high) ability. We also find that replacing CEOs with more (less) able CEOs is associated with improvements (declines) in subsequent firm performance. We conclude with a demonstration of the potential of the measure. We find that the negative relation between equity financing and future abnormal returns documented in prior research is mitigated by managerial ability. Specifically, more able managers appear to utilize equity issuance proceeds more effectively, illustrating that our more precise measure of managerial ability will allow researchers to pursue studies that were previously difficult to conduct.
This paper was accepted by Mary E. Barth, accounting.
While managers’ accounting and financial decisions are, for many, fascinating topics, selection bias poses a serious challenge to researchers estimating the decisions’ effects using non-experimental data. Selection bias potentially occurs because managers’ decisions are non-random and the outcomes of choices not made are never observable. “Selection bias due to observables” arises from sample differences that researchers can observe but fail to control. “Selection bias due to unobservables” arises from the unobservable and thus uncontrolled sample differences that affect managers’ decisions and their consequences. In this article I review two econometric tools developed to mitigate these biases – the propensity score matching (PSM) method to mitigate selection bias due to observables and the Heckman inverse-Mills-ratio (IMR) method to address selection bias due to unobservables – and discuss their applications in accounting and finance research. The article has four takeaways. First, researchers should select the correct method to alleviate potential selection bias: the PSM method mitigates selection bias due to observables, but does not alleviate selection bias due to unobservables. Second, in applying PSM researchers are advised to restrict their inferences to firms whose characteristics can be found in both the sample and control groups. Third, the IMR method, though popular, is limited to situations in which the choices are binary, the outcomes of choices are modeled in a linear regression, and the unobservables in the choice and outcome models follow a multivariate normal distribution. Researchers can overcome these constraints by using full information maximum likelihood estimation. Last, when the IMR method is used, special attention should be paid to the formulas in calculating IMRs. The article also calls for researchers’ attention to other approaches to evaluating the effects of managers’ decisions.
Financial economics has traditionally posited a limited role for idiosyncratic noneconomic manager-specific influences, but the strategic management literature suggests such individual influences can affect corporate outcomes. We investigate whether individual managers play an economically significant role in voluntary corporate financial disclosure. Tracking managers across firms over time, we find top executives exert unique and economically significant influence (manager-specific fixed effects) on their firms’ voluntary disclosures, incremental to those of known economic determinants of disclosure, and firm- and time-specific effects. We further show that managers’ unique disclosure styles are associated with observable demographic characteristics of their personal backgrounds: Managers promoted from finance, accounting, and legal career tracks, managers born before World War II, and those with military experience develop disclosure styles with conservative characteristics, and managers from finance and accounting and those with military experience favor more precise disclosure styles. These plausible associations confirm that our estimated manager-specific fixed effects capture systematic long-lived differences in managers’ unique disclosure styles.
Empirical research on pioneering advantage establishes a strong association between pioneering and market share. Researchers, however, suggest that managerial skills may account for the relationship and underscore the need to control for such skills. The authors develop efficiency measures to represent a firm's managerial skills, employing the data envelopment analysis framework as well as a regression-based approach. Furthermore, they account for unobserved, firm-specific factors that include unobserved managerial skills. With such systematic control for observed and unobserved managerial skills, they reexamine the impact of pioneering on market share and find that it is robust even after they control for managerial skills.
In this study we develop a measure of corporate tax avoidance that reduces both financial and taxable income, which we refer to as “book-tax conforming” tax avoidance. We use LIFO/FIFO inventory method conversions, as well as samples of private and public firms, to validate our measure of conforming tax avoidance. We then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that our measure of conforming tax avoidance successfully captures book-tax conforming transactions and thus, variation in conforming tax avoidance at private and public firms. Consistent with expectations, we also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures to which they are subject. For example, public firms that lack analyst following, do not issue equity securities, report lower sales growth, or smaller discretionary accruals engage in relatively more conforming tax avoidance and less nonconforming tax avoidance. Our study develops a new measure of conforming tax avoidance that should be useful in future research and it provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income.
In this paper, we present a review of tax research. We survey four main areas of the literature: (1) the informational role of income tax expense reported for financial accounting, (2) corporate tax avoidance, (3) corporate decision-making including investment, capital structure, and organizational form, and (4) taxes and asset pricing. We summarize the research areas and questions examined to date and what we have learned or not learned from the work completed thus far. In addition, we provide our opinion as to the interesting and important issues for future research.
Research on the credit rating process has primarily focused on how rating agencies incorporate firm characteristics into their rating opinions. We contribute to this literature by examining the impact of managerial ability on the credit rating process. Given debt market participants’ interest in assessing default risk, we begin by documenting that higher managerial ability is associated with lower variability in future earnings and stock returns. We then show that higher managerial ability is associated with higher credit ratings (i.e., lower assessments of credit risk). To provide more direct identification of the impact of managerial ability, we examine chief executive officer (CEO) replacements and document that ratings increase (decrease) when CEOs are replaced with more (less) able CEOs. Finally, we show that managerial ability also has capital market implications by documenting that managerial ability is associated with bond offering credit spreads. Collectively, our evidence suggests that managerial ability is an important factor that bond market participants impound into their assessments of firm credit risk.
This paper was accepted by Mary Barth, accounting.
This paper investigates the extent to which extensions of a temporary tax law reduce market participants??? ability to predict and understand corporate earnings. Examining evidence from eight separate extensions of the R&D tax credit, I find that market participants adjust their expectations for corporate earnings upwards in response to extensions of the R&D tax credit, but doing so incrementally decreases the accuracy of earnings forecasts. The evidence also suggests that abnormal bid-ask spreads around quarterly earnings announcements increase for firms affected by an expired R&D tax credit, suggesting that trading costs rise when markets have difficulty interpreting earnings affected by the expired R&D tax credit. The results of this study call attention to previously unexplored costs of temporary tax laws???capital market confusion related to corporate earnings affected by expired tax laws.
This paper and its companion, The Lessons of Stateless Income, together comprehensively analyze the tax consequences and policy implications of the phenomenon of “stateless income.” Stateless income comprises income derived for tax purposes by a multinational group from business activities in a country other than the domicile of the group’s ultimate parent company, but which is subject to tax only in a jurisdiction that is not the location of the customers or the factors of production through which the income was derived, and is not the domicile of the group’s parent company. Google Inc.’s “Double Irish Dutch Sandwich” structure is one example of stateless income tax planning in operation.This paper focuses on the consequences to current tax policies of stateless income tax planning. The companion paper extends the analysis along two margins, by considering the implications of stateless income tax planning for the reliability of standard efficiency benchmarks relating to foreign direct investment, and by considering in detail the phenomenon’s implications for the design of future U.S. tax policy in this area, whether couched as the adoption of a territorial tax regime or a genuine worldwide tax consolidation system.This paper first demonstrates that the current U.S. tax rules governing income from foreign direct investments often are misapprehended: in practice the U.S. tax rules do not operate as a “worldwide” system of taxation, but rather as an ersatz variant on territorial systems, with hidden benefits and costs when compared to standard territorial regimes. This claim holds whether one analyzes these rules as a cash tax matter, or through the lens of financial accounting standards. This paper rejects as inconsistent with the data any suggestion that current law disadvantages U.S. multinational firms in respect of the effective foreign tax rates they suffer, when compared with their territorial-based competitors.This paper’s fundamental thesis is that the pervasive presence of stateless income tax planning changes everything. Stateless income privileges multinational firms over domestic ones by offering the former the prospect of capturing “tax rents” — low-risk inframarginal returns derived by moving income from high-tax foreign countries to low-tax ones. Other important implications of stateless income include the dissolution of any coherence to the concept of geographic source, the systematic bias towards offshore rather than domestic investment, the more surprising bias in favor of investment in high-tax foreign countries to provide the raw feedstock for the generation of low-tax foreign income in other countries, the erosion of the U.S. domestic tax base through debt-financed tax arbitrage, many instances of deadweight loss, and — essentially uniquely to the United States — the exacerbation of the lock-out phenomenon, under which the price that U.S. firms pay to enjoy the benefits of dramatically low foreign tax rates is the accumulation of extraordinary amounts of earnings (about $1.4 trillion, by the most recent estimates) and cash outside the United States.Stateless income tax planning as applied in practice to current U.S. law’s ersatz territorial tax system means that the lock-out effect now operates in fact as a kind of lock-in effect: firms retain more overseas earnings than they profitably can redeploy, to the great frustration of their shareholders, who would prefer that the cash be distributed to them. This tension between shareholders and management likely lies at the heart of current demands by U.S.-based multinational firms that the United States adopt a territorial tax system. The firms themselves are not greatly disadvantaged by the current U.S. tax system, but shareholders are. The ultimate reward of successful stateless income tax planning from this perspective should be massive stock repurchases, but instead shareholders are tantalized by glimpses of enormous cash hoards just out of their reach.
We investigate the association between financial constraints and cash savings generated through tax planning. We predict that an increase in financial constraints leads firms to increase internally generated funds via tax planning. We measure financial constraints based on changes in firm-specific and macroeconomic measures. We find that firms facing increases in financial constraints exhibit increases in cash tax planning. Our results indicate that among profitable firms, firm-years with the largest increases in firm-specific constraints are associated with declines in firms' cash effective tax rates ranging from 3.00 to 5.14 percent, which equate to between 2.87 and 4.82 percent of operating cash flows. We also find that (1) the impact of financial constraints on tax planning is greatest among firms with low cash reserves, and (2) constrained firms achieve a substantial portion of their current tax savings via deferral-based tax planning strategies, despite the lack of a financial statement benefit.
JEL Classifications: E69; H25; H60.
Data Availability: Data used in this study are available from public sources identified in the paper.
We investigate the association between aggressive tax and financial reporting and find a strong, positive relation. Our results suggest that insufficient costs exist to offset financial and tax reporting incentives, such that nonconformity between financial accounting standards and tax law allows firms to manage book income upward and taxable income downward in the same reporting period. To examine the relation between these aggressive reporting behaviors, we develop a measure of tax reporting aggressiveness that statistically detects tax shelter activity at least as well as, and often better than, other measures. In supplemental stock returns analyses, we confirm that the market overprices financial reporting aggressiveness. We also find that the market overprices tax reporting aggressiveness, but only for firms with the most aggressive financial reporting.
Empirical evidence linking campaign financing activity to future firm benefits is mixed. However, theory suggests that an important aspect of a successful political strategy is a multi-period investment in cultivating relationships with key policymakers (Snyder 1992). We examine a specific setting and investigate whether firms that invest in relationships with tax policymakers via campaign contributions accrue greater future tax benefits. We find that firms that pursue a more relational approach to corporate political activity have lower future cash and GAAP effective tax rates (ETRs) and less volatile future cash ETRs. Further, we provide evidence of an incremental effect of tax-specific lobbying for firms that develop stronger relationships with tax policymakers via PAC support. Thus, our study links tax-specific PAC support to tax-specific outcomes, providing an economic link for the observed contribution-return relation documented in Cooper, Gulen, and Ovtchinnikov (2010).
Data Availability: All data are publicly available from sources as indicated in the text.
In response to recent requests from academics and practitioners, this note addresses the data and program we use in our published articles on executive compensation and incentives. First, we detail our methodology for the calculation of delta (pay-performance sensitivity), vega (risk-taking incentives), and firm-specific wealth (inside equity) for executives on the Execucomp database. Second, we provide the data on these measures for the period 1992-2010 as well as the accompanying SAS program as downloadable files on our websites. JEL classification code: G34, J33, M52 The authors are grateful to Stefan Petry for feedback on the SAS code. We enthusiastically welcome feedback on the data and program.
This paper investigates whether individual top managers affect the extent of their firms' tax avoidance. We construct a dataset that tracks the movement of managers across firms over time to identify manager effects on firms' effective tax rates. The results indicate that individual managers play a significant role in determining the level of tax avoidance that firms undertake. The economic magnitude of the manager effects on tax avoidance is large. Moving between the top and bottom quartiles of managers results in a 10.3 percent swing in effective tax rates, which has a direct and proportionally larger effect on their firms' after-tax accounting earnings. We also examine what types of managers are successful at tax avoidance. The results indicate that managers with an MBA or law degree are more likely to be associated with a lower cash effective tax rate than managers without an MBA or law degree. Dyreng acknowledges financial support from the Deloitte Doctoral Fellowship. Maydew acknowledges financial assistance from the David E. Hoffman Chair at the University of North Carolina. We thank Nemit Shroff, Jake Thornock, and the Kresge Library staff at the University of Michigan for assisting with the collection of the executive biographical data.
This paper investigates the effect tax havens and other foreign jurisdictions have on the income tax rates of multinational firms based in the United States. We develop a new regression methodology using financial accounting data to estimate the average worldwide, federal, and foreign tax rates on worldwide, federal, and foreign pretax book income for a large sample of U.S. firms with and without tax haven operations. We find that on average U.S. firms that disclosed material operations in at least one tax haven country have a worldwide tax burden on worldwide income that is approximately 1.5 percentage points lower than firms without operations in at least one tax haven country. Our results also show that U.S. firms face a 4.4% current federal tax rate on foreign income whether or not they have tax haven operations. Finally, we find that U.S. firms with operations in some tax haven countries have higher federal tax rates on foreign income than other firms. This result suggests that in some cases, tax haven operations may increase U.S. tax collections at the expense of foreign country tax collections.
In a large panel of Compustat firms, we find that firm policy changes after exogenous CEO departures do not display abnormally high levels of variability, casting doubt on the presence of idiosyncratic-style effects in policy choices. After endogenous CEO departures, we do detect abnormally large policy changes. These changes are larger when the firm is likely to draw from a deeper pool of replacement CEO candidates, suggesting the presence of causal-style effects that are anticipated by the board. Our evidence suggests that managerial styles are not transferred across employers and that standard F-tests are inappropriate for identifying style effects. © 2013 The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]
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We examine whether accounting quality is associated with efficient investments in labor, a key factor of production that has been largely overlooked in prior studies. We find evidence that abnormal net hiring (measured as the absolute deviation from net hiring predicted by economic fundamentals) is negatively associated with accounting quality. These results are robust to a battery of sensitivity tests and controls for other relevant factors, including labor power and other contemporaneous investments. We further examine the channels through which accounting quality improves net hiring efficiency and provide evidence that high quality accounting reduces both over-investment in labor (over-hiring and under-firing) and under-investment in labor (under-hiring and over-firing). We also show that the effect of accounting quality on net hiring efficiency is particularly strong in highly unionized industries. Finally, we document that abnormal net hiring is costly, in that it is associated with lower future profitability. Overall, our results are consistent with higher quality accounting facilitating more efficient investments in labor by mitigating the market frictions that stem from information asymmetry and lead to sub-optimal levels of investment. This article is protected by copyright. All rights reserved.
Introduction and Historical PerspectiveTechnical Background
Experimental ExperienceSummary Interpretation, and Examples of Diagnosing Actual Data for CollinearityAppendix 3A: The Condition Number and InvertibilityAppendix 3B: Parameterization and ScalingAppendix 3C: The Weakness of Correlation Measures in Providing Diagnostic InformationAppendix 3D: The Harm Caused by Collinearity
We investigate the relative importance of the twenty-four provisions followed by the Investor Responsibility Research Center
(IRRC) and included in the Gompers, Ishii, and Metrick governance index (Gompers, Ishii, and Metrick 2003). We put forward
an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden
parachutes, and supermajority requirements for mergers and charter amendments. We find that increases in the index level are
monotonically associated with economically significant reductions in firm valuation as well as large negative abnormal returns
during the 1990–2003 period. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either
reduced firm valuation or negative abnormal returns.
This paper examines the effect of Chief Financial Officers' (CFOs') individual philosophy or "style" on corporate accounting choices. We track 359 CFOs across different firms over time and investigate whether CFO-specific factors explain a firm's accounting choices. We find that, across a wide range of accounting choices, individual CFOs are an important determinant of accounting practices. Moreover, the effect of CFO styles appears to be stronger under conditions of high CFO discretion and high CFO job demands. We also trace the CFO style to observable CFO characteristics by examining whether CFOs' gender, age, and educational background affect their styles. We find limited evidence of the impact of these CFO characteristics on accounting choices, suggesting that these common and observable characteristics capture only a small portion of CFO styles. Taken together, our findings expand the literature on the determinants of accounting choices by highlighting manager-specific factors as a new dimension of determinants worth considering for future work in the area.
This paper investigates the effect tax havens and other foreign jurisdictions have on the income tax rates of multinational firms based in the United States. We develop a new regression methodology using financial accounting data to estimate the average worldwide, federal, and foreign tax rates on worldwide, federal, and foreign pre-tax income for a large sample of US firms with and without tax haven operations. We find that on average US firms that disclosed material operations in at least one tax haven country have a worldwide tax burden on worldwide income that is approximately 1.5 percentage points lower than firms without operations in at least one tax haven country. We also finds that US firms face a 4.4 percent current federal tax rate on foreign income whether or not they have tax haven operations. Finally, we find that firms with operations in some tax haven countries have higher federal tax rates on foreign income than other firms. This finding suggests that in some cases, tax haven operations may increase US tax collections at the expense of foreign country tax collections.
We document that firms included in the ExecuComp database tend to be larger, more complex, followed by more analysts, have greater stock liquidity levels, and have higher total, but less concentrated, institutional ownership than other firms. Based on these differences, we test and find support for three predictions. First, ExecuComp firms rely more heavily on earnings and stock returns in determining CEO cash compensation. Second, the weight on earnings is more sensitive to differences in the extent of growth opportunities for ExecuComp firms. Third, the positive relation between institutional ownership concentration and the value of stock option grants is stronger for ExecuComp firms. Overall, our results suggest that ExecuComp and non-ExecuComp firms operate in different contracting environments that lead to differences in the design of their executive compensation contracts. As a result, care should be taken in extending results based on ExecuComp samples to non-ExecuComp firms.
This paper investigates whether top executives have significant individual-specific effects on accruals that cannot be explained by firm characteristics. Exploiting 37 years of individual executive and firm data, we find that individual executives play a significant role in determining firms’ accruals. We examine whether executives’ effects on accruals are related to their personal styles on firm policies, investment, financing and operating decisions. Our results show that individual executives’ effects on accruals are more correlated with their operating decisions than investment and financing decisions. We next investigate whether managers also have a personal style for directly affecting accruals, themselves. We compare effects exerted by CEOs to CFOs. We find CEOs are more likely to affect accruals through firm policy decisions and CFOs are more likely to affect accruals through accounting decisions. CFOs tend to report more “solid” earnings than CEOs, i.e., CFOs are more likely to push accruals to zero.
Prior research in finance and accounting generally posits a limited role for idiosyncratic manager-specific attributes in explaining accounting and disclosure choices. In contrast, upper echelons theory, originating in the strategic management literature, suggests that differences among individuals can affect corporate outcomes. Extant research in voluntary disclosure follows the traditional financial economics perspective, yet even the most comprehensive empirical models leave most of the cross-sectional variation in disclosure unexplained. This prompts us to investigate whether these models are missing a major component: Do idiosyncratic differences among individual managers play a significant incremental role in voluntary corporate financial disclosure? We build a data set that tracks managers over time, which allows us to isolate manager-specific fixed effects after controlling for firm effects. We find that top executives do exhibit unique individual-specific and economically significant disclosure styles. That is, our evidence suggests that individual managers significantly influence attributes of their firms' voluntary disclosures, even after controlling for techno-economic determinants of disclosure identified in prior research, and firm- and time-specific effects. The collective magnitude of these manager-specific fixed effects is large: Manager-specific effects explain roughly as much or more of the variation in disclosure as the known techno-economic determinants combined. We then investigate whether managers' unique fixed effects are associated with observable characteristics of their own personal backgrounds. We find that managers promoted from finance, accounting, and legal career tracks, managers born before World War II, and managers holding MBAs tend to exhibit more conservative disclosure styles. These associations between our estimates of managers' fixed effects and distinctive (permanent) characteristics of their own personal backgrounds provide evidence confirming that our estimated manager fixed effects capture systematic long-lived differences in managers' unique disclosure styles. Our results suggest that individual-specific effects play an important - yet heretofore largely unexplored - role in voluntary financial disclosure. Further investigation of the role unique individual characteristics play in explaining corporate financial reporting is potentially a fruitful direction for future research.
Using confidential tax shelter and tax return data obtained from the Internal Revenue Service, this study develops and validates an expanded model for inferring the likelihood that a firm engages in a tax shelter. Results show that tax shelter likelihood is positively related to subsidiaries located in tax havens, foreign-source income, inconsistent book-tax treatment, litigation losses, use of promoters, profitability, and size; and negatively related to leverage. Supplemental tests show that total book-tax differences (BTDs) and the contingent tax liability reserve are significantly related to tax shelter usage, while discretionary permanent BTDs and long-run cash effective tax rates are not. Finally, the model is weaker, yet still significant, in the FIN 48 disclosure environment. This research provides investors and policymakers with an extended, validated measure to calculate the presence of extreme cases of corporate tax aggressiveness. Such information could also aid analysts and other tax and non-tax researchers in assessing the benefits and risks of firm behavior.
This paper investigates whether individual top executives have incremental effects on their firms’ tax avoidance that cannot be explained by characteristics of the firm. To identify executive effects on firms’ effective tax rates, we construct a dataset that tracks the movement of 908 executives across firms over time. The results indicate that individual executives play a significant role in determining the level of tax avoidance that firms undertake. The economic magnitude of the executive effects on tax avoidance is large. Moving between the top and bottom quartiles of executives results in approximately an eleven percent swing in GAAP effective tax rates; thus, executive effects appear to be an important determinant in firms’ tax avoidance.
Trueman (1986) theorizes that managers voluntarily issue earnings forecasts to signal their ability. Consistent with this theory, we find that the likelihood and frequency of management earnings forecast issuance increase with CEO ability, as proxied by (i) press citations, (ii) a measure generated from data envelope analysis, and (iii) industry-adjusted ROA during a specific CEO’s tenure. We also report that firms with high ability CEOs issue more accurate forecasts compared to firms with low ability CEOs and that the market is more responsive to the news in forecasts associated with higher ability CEOs compared to the news in forecasts associated with lower ability CEOs. These results suggest that CEO ability adds credibility to management forecasts. Overall, our study highlights that a personal characteristic of the CEO is associated with an important voluntary disclosure.
This paper examines whether managers impact firm performance when their firms are in distress. We conservatively define managerial ability as the manager’s capacity to deploy the firm’s resources. We verify the validity of our metric using a manager-firm matched panel data set which allows us to track managers (CEOs) across different firms over time. We find managerial ability is inversely related to the amount of time a firm spends in distress, the likelihood of a firm’s failure, and the cost of failure. These results suggest that the managers of failed firms are less skilled than their counterparts. But even within failed firms there is heterogeneity in the talents of managers.
This paper examines the association between ineffective internal control over financial reporting and the profitability of insider trading. We predict and find that the profitability of insider trading is significantly greater in firms disclosing material weaknesses in internal control relative to firms with effective control. The positive association is present in the years leading up to the disclosure of material weaknesses, but disappears after remediation of the internal control problems. We find insider trading profitability is even greater when insiders are more likely to act in their own self-interest as indicated by auditors’ weak “tone at the top” adverse internal control opinions and this incremental profitability is driven by insider selling. Our research identifies a new setting where shareholders are most at risk for wealth transfers via insider trading and highlights market consequences of weak “tone at the top”.
In this paper we investigate the reputational penalties to managers of firms announcing earnings restatements. More specifically, we examine management turnover and the subsequent re-hiring of displaced managers at firms announcing earnings restatements during 1997 or 1998. In contrast to prior research (Beneish 1999 and Agrawal, Jaffe and Karpoff, 1999), which does not find increased turnover following GAAP violations or revelation of corporate fraud, we find that 60% of restating firms experience a turnover in at least one top manager within 24 months of the restatement compared to only 35% among age-, size- and industry-matched firms. Moreover, 85% of the displaced managers of restatement firms are unable to secure comparable employment afterwards. Our results hold after controlling for firm performance, bankruptcy and other determinants of management turnover, and suggest that both corporate boards and the external labor market impose significant penalties on managers for violating GAAP. Also, in light of resource constraints at the SEC, our findings are encouraging as they suggest that private penalties for GAAP violations are severe and may serve as partial substitutes for public enforcement of GAAP violations.
This paper investigates whether aggressive tax planning firms have less transparent information environments. Although tax planning provides expected tax savings, it can simultaneously increase the financial complexity of the organization. And, to the extent that this greater financial complexity cannot be adequately communicated to outside parties, such as investors and analysts, transparency problems can arise. Our investigation of the association between a newly developed measure of tax aggressiveness and information asymmetry, analyst forecast errors, and earnings quality suggests that aggressive tax planning decreases corporate transparency. We also find evidence, however, that managers at tax aggressive firms attempt to mitigate these transparency problems by increasing the volume of tax-related disclosure. Overall, our results suggest that firms face a trade-off between financial transparency and aggressive tax planning thereby potentially explaining why some firms appear to engage in more conservative tax planning than would otherwise be optimal.
This paper examines how firms account for and report the tax benefits of employee stock options (ESOs). The tax benefits of ESOs reduce taxes actually owed but enter stockholders' equity directly without reducing reported income tax expense. Failing to adjust reported income tax expense for this benefit can lead to poorly specified studies with the distinct possibility of considerable measurement error and flawed inferences.
We explain the adjustments needed for more reliable estimates of effective tax rates, tax burdens, and marginal tax rates often critical to analyses of firm-specific and public policy issues. We document problems with firms' disclosures and, using a sample of large NASDAQ firms likely to be heavy users of ESOs, find that adjusting for the ESO tax benefit is essential to understanding the impact of taxes on those firms.
Offshore tax havens, such as the Cayman Islands, have been shown to facilitate corporate tax avoidance. However, academic research has overlooked the possibility that the state of Delaware could serve a similar role domestically. We find that tax factors play an important role in determining where to locate subsidiaries and that these factors are economically larger than the legal and governance factors that are typically considered important determinants of incorporation decisions. In addition, the tax savings of placing subsidiaries in the state of Delaware are economically meaningful. For firms that appear to engage in tax strategies involving Delaware, we find a reduction in the state effective tax rate of approximately 1.5 percentage points, which is similar in magnitude to the tax savings of having foreign haven operations. Our results are consistent with Delaware serving as a domestic haven against state corporate taxation.
This paper investigates whether economies of scale exist for tax planning. In particular, do larger, more profitable, multinational corporations avoid more taxes than other firms, resulting in lower effective tax rates? While the empirical results indicate that, ceteris paribus, larger corporations have higher effective tax rates, firms with greater pre‐tax income have lower effective tax rates. The negative relation between effective tax rates (ETRs) and pretax income is consistent with firms with greater pre‐tax income having more incentives and resources to engage in tax planning.
Consistent with multinational corporations being able to avoid income taxes that domestic‐only companies cannot, I find that multinational corporations in general, and multinational corporations with more extensive foreign operations, have lower worldwide ETRs than other firms. Finally, in a sample of multinational corporations only, I find that higher levels of U.S. pre‐tax income are associated with lower U.S. and foreign ETRs, while higher levels of foreign pre‐tax income are associated with higher U.S. and foreign ETRs. Thus, large amounts of foreign income are associated with higher corporate tax burdens. Overall, I find substantial evidence of economies of scale to tax planning.
We examine the extent of implicit taxes at the corporate level and the effect on implicit taxes of the Tax Reform Act of 1986 (TRA86). Using a variety of specifications, we find consistent evidence that implicit taxes eliminate virtually all of the cross-sectional differences in explicit tax preferences prior to TRA86, and then abruptly decline and eliminate only about one-third of the cross-sectional differences in tax preferences in years following TRA86. We triangulate this evidence that implicit taxes declined following TRA86 by also providing evidence (a) of a decline in the relation between changes in tax preferences and changes in pre-tax returns, (b) of an increase in the persistence of tax-related earnings changes, (c) that these dramatic economic changes are priced by investors. Finally, we provide evidence suggesting that the decline in implicit taxes after TRA86 is driven at least in part by expansion of aggressive tax planning and use of tax shelters. Taken together these results indicate that TRA86 had a profound and lasting effect on implicit taxes at the corporate level.
I examine the association between CEOs’ after-tax incentives and their firms’ level of tax avoidance. Economic theory holds that firms should compensate CEOs on an after-tax basis when the expected tax savings generated from additional incentive alignment outweigh the incremental compensation demanded by CEOs for bearing additional tax-related compensation risk. Using hand-collected data from proxy statements, I find a negative relation between the use of after-tax incentives and effective tax rates. I also find a positive association between the use of after-tax incentives and CEO cash compensation, suggesting that CEOs who are compensated on an after-tax basis demand a premium for bearing additional risk.