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Carbon Risk and Corporate Tax Avoidance: Do Institutional Investors Drive Business to Organize for Social Good?

November 2024
Strategic Change 34(1)

DOI:10.1002/jsc.2610

Authors:

Naima Lassoued

Ecole Supérieure de Commerce de Tunis

Imen Khanchel El Mehdi

Manouba University

This study investigates the impact of carbon risk on tax avoidance strategies, analyzing a dataset comprising 854 American corporations observed from 2015 to 2022. By using the two‐stage least squares (2SLS) regression method with instrumental variables, the findings provide evidence that carbon risk increases tax avoidance. Furthermore, institutional investors moderate this relationship by attenuating the positive impact of carbon risk on tax avoidance. This paper offers an in‐depth understanding of the impact of carbon risk on tax avoidance, enriching the debate on what constitutes good and bad business practices. Additionally, it adds new attributes to explore the fundamental question of what makes business good? Finally, it highlights some recommendations to advance the dialog on the concept of organizing for social good.

Descriptive statistics.

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Correlations.

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Corporate carbon risk and tax avoidance.

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Robustness checks.

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Strategic Change, 2024; 0:1–17

https://doi.org/10.1002/jsc.2610

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Strategic Change

SPECIAL ISSUE ARTICLE

Carbon Risk and Corporate Tax Avoidance: Do Institutional

Investors Drive Business to Organize for Social Good?

NaimaLassoued1,2 | ImenKhanchel2,3 | ZahraSouguir2,4

1Higher School of Commerce of Tunis, Manouba, Manouba, Tunisia | 2QuAnL ab LR2 4ES21, ESCT, University of Manouba, Manouba, Tunisia |

3LAR IME LR11ES02, ES SECT, University of Tunis, Tunis, Tunisia | 4Higher Institute of Accountancy and Enterprises Administration, University of

Manouba, Manouba, Tunisia

Correspondence: Naima Lassoued (naima.lassoued@sesame.com.tn)

Received: 15 November 2023 | Revised: 17 July 2024 | Accepted: 7 September 2 024

Keywords: agency theory| business ethics| environmental sustainability| neoinstitutional theor y

ABSTRACT

This study investigates the impact of carbon risk on tax avoidance strategies, analyzing a dataset comprising 854 American

corporations observed from 2015 to 2022. By using the two- stage least squares (2SLS) regression method with instrumental

variables, the findings provide evidence that carbon risk increases tax avoidance. Furthermore, institutional investors moderate

this relationship by attenuating the positive impact of carbon risk on tax avoidance. This paper offers an in- depth understand-

ing of the impact of carbon risk on tax avoidance, enriching the debate on what constitutes good and bad business practices.

Additionally, it adds new attributes to explore the fundamental question of what makes business good? Finally, it highlights some

recommendations to advance the dialog on the concept of organizing for social good.

1 | Introduction

In today's dynamic business environment, a company's overall suc-

cess—involving ethical practices, sustainable strategies, and stake-

holder satisfaction—is crucial for its long- term viability. Going

beyond profitability, prioritizing these elements raises trust, loyalty,

and a positive reputation, driving sustainable growth and societal

benefits. There are several factors that contribute to the overall

goodness of business. One key aspect that has captured significant

attention from both scholars and practitioners over the past de-

cades is the mitigation of carbon risk, the potential threat that com-

panies and investors face due to their exposure to carbon emissions

and their efforts to mitigate them (Bose, Minnick, and Syed2021).

As companies are increasingly acknowledging the risks asso-

ciated with carbon emissions, such as reputational and eco-

nomic damage, carbon price volatility threats, and potential

impacts on growth and competitiveness (Kim, An, and Kim2015;

Nguyen2018), they have implemented proactive strategies to re-

duce greenhouse gas (GHG) emissions and transition toward

cleaner energy sources. However, setting targets to reduce carbon

emissions can impact firms' production and operational decisions

due to compliance costs and additional carbon- related expenses

(Clarkson etal.2015; Feng etal.2022). For instance, investing in

environmentally friendly technologies and practices often involves

substantial costs. Additionally, operational expenses related to re-

newable energy sources, training, regulatory compliance, research

and development, among others, can accumulate. These costs,

along with other profit- reducing factors, might prompt managers

to conceal expenses, including tax liabilities, to maximize profit-

ability (Arieftiara et al. 2019). Influenced by market pressures,

restrictive regulatory frameworks, and increasing stakeholder ex-

pectations, managers may be inclined to engage in tax avoidance,

defined as any intentional effort to decrease a taxpayer's explicit tax

liability (Hanlon and Heitzman2010) through planned actions to

minimize tax payments, which can vary from legal to questionable

or illegal practices (Chen etal.2010). Tax avoidance aims to divert

focus from unfavorable financial performance and mitigate the un-

favorable impacts of carbon- related news through financial report-

ing (Arieftiara etal. 2019; Hutchens, Rego, and Williams 2019).

2 of 17 Strategic Change, 2024

However, in many jurisdictions, governments provide tax incen-

tives to encourage companies to reduce their GHG emissions,

thereby decreasing the motivation for tax avoidance. Tax credits,

deductions, or other benefits are often available to companies in-

vesting in cleaner tech nologies, util izing renewable energy sources,

or adopting environmentally friendly practices (Yu etal.2021).

Under these conflicting perspectives, this paper aims to explore

the impact of carbon risk on tax avoidance among American

firms. The U.S. context is particularly interesting for several rea-

sons. First, the U.S. stands as the second- largest carbon dioxide

emitter globally, making its commitment to achieve a 50%–52%

decrease in GHG emissions from 2005 levels by 2030 a pivotal

environmental target (United States Environmental Protection

Agency2023). Consequently, the US government and firms face

a significant environmental challenge (Khanchel, Las soued, and

Bargaoui2024). Second, the U.S. has actively engaged in global

efforts to control GHG emissions, despite fluctuations in com-

mitment across different government administrations (Ahmed,

Shuai, and Ahmed 2023). This inconsistency in environmen-

tal policy introduces uncertainty for companies in managing

their carbon risk (Lassoued and Khanchel2023). Third, major

American corporations, according to (Hanauer's 2021) analy-

sis by the Institute on Taxation & Economic Policy, are deeply

involved in tax avoidance activities, with 55 firms reported

not paying taxes. This scenario requires an investigation into

whether carbon risk serves as a driver for this tax avoidance.

Interestingly, there is an empirical gap as few studies has ex-

amined the impact of sustainability commitment, particularly

carbon risk, on tax avoidance. Specifically, these studies focused

on environmental regulation and tax avoidance engagement in

countries like China (e.g., Yu etal.2021; Yang etal.2022; Feng

et al. 2022) rather than the risk associated with carbon emis-

sions. Additionally, these studies draw conclusions from the

regulator's perspective rather than considering the viewpoint

of corporations. Furthermore, a study by Onuma and Shimada

(2018) concentrated on environmental protection costs and tax

avoidance among Japanese firms, but its findings cannot be

generalized to other contexts due to the unique nature of the

Japanese markets, necessitating further investigations. Notably,

the cited studies do not address the moderating effect of some

governance mechanisms, especially ownership structure, which

may reinforce or weaken the relationship between carbon risk

and tax avoidance. Previous research highlights that the owner-

ship structure of a firm is a crucial determinant of corporate tax

planning strategy (Hanlon and Heitzman2010), particularly tax

avoidance (e.g., Embree and Crabtree2012). Additionally, prior

studies show that variation in sustainability commitment can be

explained by institutional owners (Dyck etal.2019). For exam-

ple, in many cases, institutional investors exert pressure on com-

panies to address their exposure to carbon emission risk (Bolton

and Kacperczyk 2021). Therefore, we advance this stream of

research by testing how institutional investors affect the link

between carbon risk and tax avoidance.

Therefore, we propose to address the following research

questions:

RQ1. How does carbon risk affect tax avoidance?

RQ2. Is the relationship between carbon risk and tax avoidance

moderated by institutional investors?

Examining a sample of 854 US firms from 2015 to 2022, and

using a 2SLS regression technique with instrumental variables,

we find that carbon risk exerts a significant positive influ-

ence on tax avoidance, and institutional investors weaken this

relationship.

This paper aims to expand our comprehension of what defines

a good or bad business, and more crucially, to examine whether

businesses truly organize for social good when faced with com-

plex challenges such as carbon risk and tax obligations. The

concept of ‘Business Organize for Social Good’ is increasingly

relevant in today's corporate landscape, where companies must

balance environmental responsibilities, financial performance,

and ethical considerations. This study contributes to this discus-

sion by exploring the intersection of carbon risk management

and corporate tax practices, two areas that significantly impact

both business operations and societal welfare. We posit that the

relationship between a company's approach to carbon risk and

its tax strategies explain its commitment to organizing for so-

cial good. This perspective offers a novel perspective through

which to evaluate corporate behavior and its alignment with so-

cietal benefit. By examining this relationship, we aim to shed

light on whether businesses are truly integrating social and

environmental concerns into their core strategies, or if they are

merely engaging in low level of corporate social responsibility

(CSR). On one hand, some companies, facing additional costs

to comply with carbon- related environmental regulations, may

be tempted to reduce their tax burden by employing more ag-

gressive tax avoidance strategies to offset these expenses. This

behavior could classify them as ‘bad’ companies, as they prior-

itize maximizing profits at the expense of society. However, on

the other hand, certain companies may be incentivized to adopt

more environmentally responsible practices to reduce their ex-

posure to carbon risk. This could lead to enhanced transparency

and accountability, consequently reducing their reliance on

tax avoidance strategies. By integrating carbon considerations

into their operations, these companies can not only mitigate the

risks associated with climate change but also enhance their rep-

utation and image. This, in turn, discourages the use of prac-

tices incompatible with a socially responsible corporate image,

Summary

• Many companies have integrated carbon risk man-

agement into their business and financial strategies to

confront the challenges of climate change.

• The management of carbon risk incurs additional

expenses.

• Companies, motivated by tax incentives for reducing

their greenhouse gas (GHG) emissions through car-

bon risk management, find an additional reason to

engage in tax avoidance.

• Institutional investors moderate this relationship by

attenuating the positive impact of carbon risk on tax

avoidance.

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thereby discouraging companies from turning to tax avoidance

strategies. Therefore, effective carbon risk management has

the potential to not only decrease tax avoidance practices but

also redefine the perception of what constitutes a ‘good’ com-

pany by emphasizing environmental and social responsibility.

Ultimately, this highlights the growing importance for compa-

nies to incorporate carbon risk into their tax strategies, enrich-

ing the debate on what makes business good? Finally, our study

investigates the role of institutional investors in affecting these

corporate behaviors. This aspect adds depth to the ongoing de-

bate about the influence of external stakeholders in driving busi-

nesses toward good business and societal well- being.

The following sections of this paper are structured as follows:

Sect ion 2 provides the theoretical framework, Section 3 pres-

ents the literature review and develops the research hypotheses,

Section4 outlines the research methodology, Section5 discusses

the results, and Section6 concludes the paper.

2 | Theoretical Framework: Carbon Risk and Tax

Avoidance: Does Making Business Good Matter?

When considering the relationship between carbon risk and

tax avoidance, we explore divergent viewpoints on what distin-

guishes good and bad businesses.

According to legitimacy theory (Selznick 1957; Meyer and

Rowan1977), companies aim to maintain a positive reputation

among their stakeholders, which is often linked to their adher-

ence to social, environmental, and fiscal standards. Legitimacy

theory posits several fundamental principles to elucidate how

companies maintain their social and institutional legitimacy.

The primary is organizational isomorphisms, including coer-

cive, mimetic, and normative isomorphisms (DiMaggio and

Powell 1983). Firms often copy the structures, practices, and

behaviors of their peers or yield to institutional pressures.

Addressing carbon risk, companies might face coercive pres-

sure from regulators and stakeholders to diminish their carbon

footprint (Lassoued, Souguir, and Khanchel 2024; Souguir etal.

2024). These pressures could also be heightened by mimetic iso-

morphisms, as companies imitate emissions reduction practices

observed in their industry to stay competitive and safeguard

their legitimacy. Similarly, companies might experience nor-

mative isomorphisms, where societal norms and stakeholder

expectations drive the adoption of environmentally sustainable

practices. Consequently, companies dealing with carbon risk are

inclined to adopt more transparent and compliant fiscal prac-

tices to maintain their social and institutional legitimacy.

A second principle of legitimacy theory is institutional legiti-

macy, which asserts that companies aim to adhere to the norms,

values, and expectations of their institutional environment to be

viewed as legitimate by stakeholders (Suchman1995; Scott1995;

Zucker 1987). This involves complying with laws and regula-

tions, as well as adopting socially accepted practices and behav-

iors (Oliver1991; Powell and DiMaggio1991).

A third principle is performance- based legitimacy (Dowling

and Pfeffer 1975; Zimmerman and Zeitz2002). Unlike institu-

tional legitimacy, which depends on adherence to established

social and cultural norms, performance- based legitimacy con-

cerns the perception that an organization is legitimate due to

its results and its ability to achieve its objectives. Performance-

based legitimacy serves as a crucial mechanism for explaining

how companies are motivated to adopt more environmentally

and fiscally responsible practices. Companies are motivated

to invest in sustainability initiatives and reduce their environ-

mental impact, thereby mitigating carbon risk, to maintain this

performance- based legitimacy. Similarly, companies that fulfill

tax obligations and avoid tax avoidance practices can be per-

ceived as tax legitimate (Sikka 2013; Wang, Wang, etal.2020;

Wang, Xu, etal.2020).

According to legitimacy theory, a ‘good’ company, addressing

carbon risk has the potential to reduce ta x avoidance practices in

several ways by emphasizing the significance of environmental

and social concerns (Deegan 2002; Dowling and Pfeffer1975).

First, as stakeholders become more environmentally conscious,

companies are motivated to reduce their carbon footprint to

enhance their legitimacy (Cho and Patten2007). By doing so,

companies are viewed as more ethical and responsible, strength-

ening their legitimacy and averting the reputational risks as-

sociated with tax avoidance (Lanis and Richardson 2012).

Consequently, companies are encouraged to adopt transparent

and compliant tax practices to maintain this positive image

(Hardeck and Hertl 2014). Second, companies committed to

mitigating carbon risk often face stringent environmental regu-

lations (Porter and Van der Linde1995). These regulations may

offer financial incentives for adopting eco- friendly practices, but

also impose penalties for non- compliance (Ambec et al. 2013).

Consequently, companies are driven to invest in environmen-

tally sustainable technologies and practices to avoid penalties

(Lanoie etal.2011). Such investments can diminish the tax ad-

vantages of avoidance strategies, as expenses for environmen-

tal compliance are often deductible from taxes (Schaltegger

and Synnestvedt 2002). Third, companies rely on external re-

sources such as financial capital, skilled personnel, and stra-

tegic partnerships for their survival and growth (Pfeffer and

Salancik1978). Maintaining social and institutional legitimacy

is crucial to keeping these external resources (Suchman 1995).

By addressing carbon risk, companies enhance their reputation

and legitimacy among stakeholders, thereby improving their

access to resources (Bansal and Clelland 2004). To preserve

these resources and maintain their legitimacy, companies may

be encouraged to adopt transparent and ethical tax practices

(Hoi, Wu, and Zhang 2013). Finally, efforts to mitigate carbon

risk often involve increased transparency, including disclos-

ing carbon emissions, investments in clean technologies, and

sustainability initiatives (Kolk, Levy, and Pinkse 2008). This

heightened transparency may also extend to a company's tax

practices (Christensen, Murphy, and Sikka 2015). When com-

panies divulge more information about their carbon reduction

efforts, they may likewise be compelled to disclose more details

about their tax strategies (Hardeck, Harden, and Upton2021).

This transparency reduces the opportunity for tax avoidance

practices that could be considered unethical or non- compliant

(Dyreng, Hoopes, and Wilde2016).

From an opposing viewpoint, the effect of carbon risk may be

explained by opportunistic behavior, drawing insights from

agency theory (Jensen and Meckling 1976). According to this

4 of 17 Strategic Change, 2024

perspective, agency costs may arise when stakeholders' carbon-

related interests do not align with those of managers (Jung,

Herbohn, and Clarkson2018). Investors typically expect man-

agers to pursue effective carbon management plans, adhering

to industry standards and environmental regulations to re-

duce carbon risk exposure (Thompson and Rayner1998), thus

enhancing long- term financial goals (Kordsachia, Focke, and

Velt e2021). However, managers may be inclined to adopt riskier

environmental choices and invest in carbon- intensive schemes

(Zhou etal.2018) to satisfy their personal interests (Cheng, Xu,

and Li 2018). This could result in externalizing carbon pollu-

tion and increasing the risk associated with future carbon

regulation policies (Goss and Roberts 2011; Wang, Wu, and

Zhang2022). Additionally, involvement in potentially profitable

carbon- related projects may negatively impact firms' short- term

financial performance and cash flows (Labatt and White2011;

Luo and Tang 2014), leading shareholders to pressure manag-

ers to downplay carbon performance and prioritize current cash

flows (Armstrong, Guay, and Weber2010; Kordsachia, Focke,

and Velte 2021). To meet shareholders' financial preferences,

managers may engage in higher levels of tax avoidance and

extensive financial reporting to divert attention from negative

news related to carbon- intensive plans (Feng etal. 2022). This

conduct is characteristic of ‘bad’ companies, as they prioritize

profit maximization at the expense of society. Faced with sig-

nificant carbon risk, bad companies may turn to tax avoidance

as a financial strategy to mitigate external risks and liquidity

constraints (Beck, Lin, and Ma2014).

3 | Literature Review and Hypotheses

Development

3.1 | Carbon Risk and Tax Avoidance

Empirically, there is limited literature exploring the role of en-

vironmental (carbon) regulation in firms' tax avoidance behav-

ior (Yu etal.2021; Geng etal.2021; Feng etal. 2022). Using a

sample of Chinese carbon- emitting industries, Yu etal.(2021)

found that heightened environmental regulation significantly

promoted firms' tax avoidance in well- regulated cities. In the

U.S. context, the effect of environmental performance on tax

policy remains unexplored. Previous studies have primarily fo-

cused on the consequences of CSR performance. For instance,

Huseynov and Klamm (2012) did not find a significant rela-

tionship between CSR and effective tax rates (ETRs), except for

coefficients related to the strength of CSR, which were mostly

negative. Hoi, Wu, and Zhang (2013) demonstrated that US

companies with excessively irresponsible CSR activities were

more likely to engage in tax avoidance. Conversely, Davis

etal.(2016) found that high CSR US firms engaged in more tax

avoidance.

Based on the above, we postulate that the effect of carbon risk

on tax avoidance practices is positive in the United States. US

firms engage in practices that make business bad for many rea-

sons. First, US companies operate within a complex regulatory

landscape, where environmental regulations arise from both

federal and state governments (Coglianese and Nash 2017).

These policies can vary significantly across states and impact

companies' compliance costs (Shapiro and Walker 2018). The

federal government has introduced stricter regulations on car-

bon emissions and tax incentives to promote the adoption of sus-

tainable practices (Metcalf2009). Faced with these regulations,

some companies, particularly those identified as bad firms,

may seek ways to minimize their taxes to offset the additional

costs of environmental compliance, potentially leading to an

increase in tax avoidance (Hsu, Li, and Tsou2018). Moreover,

the US tax system is sophisticated, offering numerous opportu-

nities for companies to optimize their tax positions (Hanlon and

Heitz man 2010). Tax deductions, credits, and other incentives

can encourage investments in clean technologies or sustain-

able practices (Aldy 2020). However, this complexity can also

be used by certain companies, particularly those identified as

bad firms, to evade their tax obligations using sophisticated tax

schemes (Lisowsky 2010). Additionally, US companies often

possess substantial resources to influence the political process

through lobbying and contributions to political campaigns

(Kang 2016). They can exert pressure on legislators to shape

tax and environmental policies favorably toward their busi-

ness interests (Richter, Samphantharak, and Timmons 2009).

Consequently, they may push for tax breaks or resist stricter

environmental regulations, creating an environment condu-

cive to tax avoidance (Kim and Zhang2 016). Furthermore, US

companies face intense global competition, compelling them to

minimize costs, including tax burdens, to remain competitive

(De Simone, Klassen, and Seidman 2017). The additional costs

associated with environmental regulations can heighten this in-

centive, prompting companies, particularly those identified as

bad firms, to seek ways to reduce taxes to sustain profitability

(Hasan etal.2017).

In conclusion, carbon risk can contribute to an increase in tax

avoidance among US companies, particularly those identified as

bad firms.

Therefore, we propose our hypothesis as follows:

H1. Corporate carbon risk increases tax avoidance in US firms.

3.2 | The Moderating Role of Institutional

Investors

The literature on ownership structure suggests that the pres-

ence of institutional investors has a positive impact on reducing

managerial opportunism (Stearns and Mizruchi1993). Previous

studies have indicated a negative relationship between institu-

tional owners (such as mutual funds, investment firms, insur-

ance companies, etc.) and corporate tax avoidance (Khurana

and Moser 2013), suggesting that institutional ownership en-

hances the monitoring of CEOs (Hoskisson and Turk1990).

Theoretically, we posit that institutional investors moder-

ate the relationship between carbon risk and tax avoidance.

Institutional players are assumed to possess significant finan-

cial resources (Agrawal and Mandelker1992) and the necessary

expertise, allowing them to gain superior access to information

(McConnell and Servaes 1990), and ensure effective manage-

ment (Coffee 1991). According to the efficient- monitoring hy-

pothesis (Pound1988), institutional investors are anticipated to

strengthen managerial decisions that promote firm sustainability

5 of 17

commitments and avoid practices detrimental to shareholders'

interests, such as tax avoidance. More specifically, investors can

utilize their network and monitoring experience to effectively

guide firms' decisions (Denes, Karpoff, and McWilliams 2017).

Institutional investors have the capability and often the influence

to shape corporate strategies, such as those related to manag-

ing carbon risk. Institutional investors drive firm sustainability

(Dyck etal.2019), indicating that they can use their professional

knowledge and monitoring experience to mitigate carbon risk.

In this study, we consider institutional investors as a moderat-

ing factor that enhances the management of carbon risk while

potentially mitigating tax avoidance. Specifically, institutional

investors are more inclined to address carbon risk due to their

heightened concern for reputational damage (Hirshleifer1993).

These investors often adhere to investment policies that prior-

itize environmental sustainability and responsible corporate

governance. They exert pressure on companies to address their

exposure to carbon emission risk (Bolton and Kacperczyk2021)

and disclose information regarding tax practices, including

those related to tax avoidance (Khurana and Moser2013). This

increased transparency can limit companies' opportunities for

tax avoidance.

Moreover, institutional investors typically hold significant vot-

ing rights at shareholder meetings (Shleifer and Vishny 1986;

Brickley, Lease, and Smith 1988), empowering them to influence

engagement efforts aimed at encouraging changes in compa-

nies' carbon risk and tax policies and practices. By threatening

to vote against company resolutions that do not align with their

sustainability expectations, institutional investors incentivize

companies to adopt more environmentally and fiscally respon-

sible behaviors.

Furthermore, institutional investors are often focused on

long- term risk management (Elyasiani and Jia2010; Ryan and

Schneider 2002) and sustainable value creation for their port-

folios. They increasingly recognize the risks associated with

climate change and environmental regulations (Pfeifer and

Sullivan 2008), as well as the reputational risks linked to ag-

gressive tax practices. Consequently, they may prefer companies

that are actively reducing their carbon footprint and adopting

responsible tax practices, as these actions can mitigate long-

term risks.

Thus, consistent with the monitoring hypothesis, we suggest

that institutional owners can play an important monitoring role

in firms, leading to reinforcing their carbon risk management

and limiting CEOs' discretion from pursuing a self- serving

agenda regarding corporate tax avoidance.

However, it is important to point out that institutional investors

exhibit distinct orientations and investment behaviors. Portfolio

diversification, turnover, trading strategies, and investment

horizons significantly influence institutional investors' con-

duct (Cronqvist and Fahlenbrach 2008; Edmans 2014). In this

context, we differentiate between transient, dedicated, or quasi-

indexing institutional investors (Bushee 1998, 2004).

In US firms, pension funds rank among the largest institu-

tional investors, managing billions, if not trillions, of dollars in

assets. For instance, the CalPERS (California Public Employees'

Retirement System) pension fund stands as one of the largest

in the country. Additionally, US insurance companies hold sub-

stantial amounts of assets. Companies like MetLife, Prudential

Financial, and AIG are among the largest insurance companies

in the United States. These investors are classified as dedicated

investors with a longer- term investment strategy and specific

objectives, such as building a diversified portfolio to achieve sta-

ble and sustained returns over the long term.

It is also worth noting that institutional investors in the U.S.

may not be as sensitive to certain pressures for various reasons.

Pension funds and endowments, for example, have long- term

investment horizons and are therefore less responsive to short-

term pressures, as their objective is to maximize returns over

the long term to fulfill their pension or ongoing financial sup-

port obligations. Additionally, institutional investors in the U.S.

often maintain diversified portfolios consisting of various types

of assets and asset classes. This diversification can reduce their

sensitivity to short- term fluctuations in individual markets.

Moreover, institutional investors in the U.S., particularly in-

surance companies and pension funds, must maintain their

long- term financial solvency to fulfill their obligations to their

beneficiaries or policyholders. Consequently, their investment

decisions may prioritize capital preservation and sustain-

able returns over impulsive reactions to external pressures.

Furthermore, institutional investors in the U.S. typically adhere

to rigorous decision- making processes involving thorough anal-

ysis, periodic reviews, and risk assessments, which help mitigate

hasty reactions to external pressures and maintain a disciplined

approach to managing investment portfolios.

Previous studies suggest that pressure- insensitive institutional

investors often foster investment relationships with investee

companies. However, other investors may be sensitive to pres-

sure from management and controlling shareholders if business

relationships exist (Cornett et al. 2007). Therefore, pressure-

insensitive investors are more likely to fulfill their monitor-

ing role than pressure- sensitive investors (Almazan, Hartzell,

and Starks 2005; Sahut, Gharbi, and Gharbi 2011). Pressure-

insensitive investors have an incentive to become involved in

the management of the company (Cornett etal. 2007).

In light of the preceding discussion, institutional investors in the

U.S. are more likely to promote strategies aimed at reducing car-

bon risk and have greater incentives to encourage firms to adopt

fair tax strategies by discouraging tax avoidance. Therefore, we

formulate the following hypothesis:

H2. Institutional investors negatively mod erate the relationship

between corporate carbon risk and tax avoidance in US firms.

4 | Research Design

4.1 | Sample Selection and Data Collection

Our sample selection process was carefully designed to en-

sure the reliability and relevance of our data for examin-

ing the relationship between carbon risk and tax avoidance

6 of 17 Strategic Change, 2024

practices. Thedifferent steps of the sample selection are re-

ported in Table 1. We used two comprehensive and widely

recognized databases: TruCost for carbon risk information

and Compustat North America for financial data. TruCost is

renowned for its robust environmental data, particularly in

quantifying corporate carbon emissions and associated risks.

Compustat North America, is a standard source for corporate

financial information, ensuring the accuracy and comparabil-

ity of our financial metrics.

The study period of 2015–2022 was chosen to capture recent

trends in both carbon risk management and tax practices. This

timeframe is particularly relevant as it includes the period follow-

ing the Paris Agreement of 2015, which marked a significant shift

in global climate policy and corporate environmental conscious-

ness. It also allows us to observe potential changes in corporate

behavior over time, providing a more comprehensive view of the

evolving relationship between carbon risk and tax avoidance.

Our decision to exclude financial companies (SIC codes 6000–

6999) from the sample was based on the unique nature of their

financial statements and regulatory environment. Financial

institutions often have distinct tax situations and carbon risk

profiles that could potentially skew our results. By focusing on

non- financial firms, we ensure a more homogeneous sample, al-

lowing for more meaningful comparisons across companies and

industries.

The process of removing companies with missing data was con-

ducted systematically to maintain the integrity of our analysis.

We specifically excluded firms lacking essential variables such

as carbon emissions data, tax information, or key financial met-

rics necessary for calculating our dependent and independent

variables.

Our final sample of 854 non- financial firms, resulting in 6595

firm- year observations.

4.2 | Variables and Measures

4.2.1 | Dependent Variables (TAXAVOID)

In our pursuit of quantif ying tax avoidance practices, we

adopt three well- established proxies. The ETR serves as a

fundamental measure, widely employed in previous studies

as it captures firms' tax avoidance strategies (Wang, Wang,

et al. 2020; Wang, Xu, et al. 2020; Geng et al. 2021; Feng

etal.2022). ETR, which is inversely related to tax avoidance,

reflects the tax expenses of firms relative to their taxable

income.

Companies with reduced ETRs serve as evidence of a higher

propensity to engage in tax avoidance by minimizing their

taxable income (Gulzar et al. 2018; Souguir, Lassoued, and

Bouzgarrou 2024). Our first measure, ETR1, is calculated

by dividing current income tax expense by pretax account-

ing income (Alsaadi 2020). The second measure, ETR2, is

determined as total tax expenses scaled by operational cash

flows (Lanis and Richardson2012). Lastly, the third measure,

CETR, reveals an array of tax- avoiding strategies by captur-

ing actual cash tax savings (Huseynov and Klamm 2012). It

is computed as taxes paid in cash scaled by pretax accounting

income minus special items. Lower values for ETR1, ETR2, or

CETR correspond to a higher degree of tax avoidance.

4.2.2 | Independent Variables (CARBON)

In line with previous research (Bolton and Kacperczyk 2021;

Wang, Wu, and Zhang 2022; Swinkels and Markwat 2023;

Aswani, Raghunandan, and Rajgopal 2023), we use two vari-

ables to evaluate corporate carbon risk. The first variable, GHG

intensity (GHG), measures total GHG emissions relative to the

firm's revenues (in US million dollars). Our second variable, ab-

solute GHG emissions (GHGa), quantifies the volume of emitted

carbon (tons of CO2- equivalent per year).

4.2.3 | Moderating Variable (INST)

We measure institutional ownership (INST) by calculating the

percentage of total shares held by the top five institutional inves-

tors in a firm (Hartzell and Starks2003).

4.3 | Econometric Specification

First, we examine the relationship between corporate carbon

risk and tax avoidance using instrumental variable regression.

We run the following empirical model:

Subsequently, institutional ownership (INST) is introduced as

the moderating variable in the relationship between corporate

carbon risk and tax avoidance.

(1)

TAXAVOID

it =𝛼0+𝛼1

CARBON

it +𝛼2

SIZE

it +𝛼3

ROA

+𝛼4GEARit +𝛼5BTMit +𝛼6CAPEXit

+𝛼

BIG+

∑

Year

∑

Industry

+𝜀

(2)

TAXAVOID

it =𝛼0+𝛼1

CARBON

it +𝛼2

INST

+𝛼3CARBONit ∗INSTit +𝛼4SIZEit +𝛼5ROA

+𝛼6GEARit +𝛼7BTMit +𝛼8CAPEXit +𝛼9BIG

∑

Yearit +

∑

Industryit +𝜀it

TABLE  | Sample selection.

Firm- year observations

Total firm- year observations matched across

Compustat and Trucost databases

23,418

Less financial sector firms 5354

Less observations with missing institutional

investor data

6345

Less observations with missing control variables 5124

Final sample after all exclusions (854 firms) 6595

7 of 17

where TAXAVOID represents tax avoidance captured by one

of three proxies (ETR1, ETR2, and CETR). CARBON denotes

corporate carbon risk, measured by GHG intensity (GHG) and

absolute GHG emissions (GHGa).

Following prior research (Mao2019; Yoon, Lee, and Cho2021;

Khan et al. 2022; Yang et al. 2022; Compagnie, Struyfs, and

Torsin 2023; Souguir, Lassoued, and Bouzgarrou 2024), the

control variables include the natural logarithm of total assets

(SIZE), net income divided by total assets (ROA), total debt

scaled by total assets (GEAR), book- to- market ratio (BTM),

capital expenditures to total assets (CAPEX), and audit quality

measured through a dummy variable that takes 1 if the firm is

audited by a BIG41 and 0 other wise (BIG).

AppendixA provides detailed variable definitions.

Year and Industry are included as industry and year- fixed effects

indicators.

Our use of the instrumental variable technique is crucial in

addressing potential causal relationships between carbon

emissions and tax avoidance. The instrumental variable must

be correlated with the endogenous variable (carbon emission)

while remaining uncorrelated with the regression error of the

model, except for its correlation with the endogenous variable.

Government policies, such as tax incentives for clean technol-

ogies, can influence both carbon emissions and tax strategies.

Additionally, companies might employ tax- avoidance strategies

related to their geographic location, potentially impacting both

production activities and carbon emissions. To mitigate these

concerns, we employ oil price as an instrument. Empirical stud-

ies have demonstrated that rising oil prices correlate with de-

creased carbon emissions (Al- Mulali etal.2016; Ullah, Chishti,

and Majeed2020), while this variable does not affect tax avoid-

ance. Consequently, oil price serves as an ideal instrument in

our two- stage regression (2SLS) estimation method.

5 | Empirical Results

5.1 | Descriptive Statistics

Table2 presents the descriptive statistics of the variables. The

mean values for ETR1 and ETR2 are 12.7% and 9.3%, respec-

tively. Additionally, the average CETR is 0.126, indicating that

US firms pay 12.6% of their pretax income. Notably, ETR1,

ETR2, and CETR fall below the corporate tax rate applied

in the USA, which was 21% from 2018 to 2023. These find-

ings suggest a trend of tax avoidance proxies lower than those

reported in prior studies conducted within the U.S. context

(Watson 2015; Chyz etal.2019). In terms of carbon intensity,

the mean GHG value is 3.308, signif ying that the average com-

pany emits 330.8 tons of CO2 per million US dollars. When

examining absolute carbon emissions intensity, the averages

is 4.668.

Table3 displays the Pearson correlations between variables. As

expected, ETR1, ETR2, and CETR show positive and significant

correlations. Also, we observe a negative and significant correla-

tion between GHG and tax avoidance proxies. This result aligns

with our expectations, indicating that companies with higher

carbon emissions intensity tend to be more involved in tax

avoidance strategies. Additionally, it is crucial to highlight the

weak correlations observed among the independent variables.

These weak correlations signif y the absence of multicollinearity

issues.

5.2 | Results and Discussion

Hypothesis 1 predicted positive effects for corporate carbon risk

on firms' tax avoidance. We tested this hypothesis using the

instrumental variable in the two- stage regression (2SLS) esti-

mation method. Table 4, columns (1), (2), and (3) (columns (4),

(5), and (6)) display the results of the models testing the effect

of GHG intensity (absolute GHG) on ETR1, ETR2, and CETR.

Consistent with H1 prediction, results indicated a significant,

positive relationship between carbon risk and tax avoidance,

aligning with agency theory. This finding contradicts the ex-

pectations of legitimacy theory, which would predict a neg-

ative association between carbon risk and tax avoidance. Our

results contribute to the growing body of literature examining

the relationship between corporate environmental responsibil-

ity and tax avoidance. While some studies have found a nega-

tive relationship between CSR and tax avoidance (Lanis and

Richardson2012; Hoi, Wu, and Zhang2013), our findings sug-

gest that the relationship may be more complex when specifi-

cally considering carbon risk.

The positive association between carbon risk and tax avoid-

ance can be explained through the perspective of agency the-

ory (Jensen and Meckling1976). Carbon risk creates divergent

incentives between shareholders and CEOs. Shareholders,

who generally seek to maximize the value of their investment

over the long term, may favor investments in carbon reduc-

tion and sustainable practices (Flammer 2013). In contrast,

CEOs may be more concerned with short- term financial

TABLE  | Descriptive statistics.

Var iables Mean SD Min Max

ETR1 0.127 0.293 −1.011 1.654

ETR2 0.093 0.409 −1.806 1.899

CETR 0.126 0.278 −1.302 1.451

GHG 3.308 2.201 −2.808 7.895

GHGa 4.668 1.435 1.477 8.430

INST 0.281 0.133 00.602

SIZE 8.421 1.803 3.066 12.367

ROA −0.011 0.186 −1.051 0.281

GEAR 0.639 0.258 0.095 0.897

BTM 0.453 0.547 −1.386 3.097

CAPEX 0.042 0.048 00.259

BIG 0.485 0.500 0 1

Note: This t able outlines the descriptive statistics for a sample of 6595 f irm-

observations. See variable definitions in AppendixA.

8 of 17 Strategic Change, 2024

results and resist costly carbon reduction initiatives that could

affect immediate profits and their personal financial incen-

tives (Deckop, Merriman, and Gupta2006). Our findings also

align with the concept of ‘organized hypocrisy’ proposed by

Cho et al. (2015), where firms may engage in contradictory

practices—in this case, increasing tax avoidance while fac-

ing pressures to address carbon risk. This behavior reflects

the complex trade- offs firms face in balancing environmen-

tal responsibilities with financial performance. The positive

association between carbon risk and tax avoidance in our

study can be further contextualized by recent developments

in tax avoidance research. For example, Dyreng, Hoopes, and

Wilde (2020) demonstrated that public scrutiny can signifi-

cantly inf luence corporate tax behavior, with firms reducing

their tax avoidance following negative media coverage.

While some studies have found a positive relationship between

environmental and financial performance (e.g., Hart and Ahuja

1996), our findings suggest that firms may be using tax avoidance

as a means to offset the costs associated with managing carbon

risk. These findings highlight the challenge that companies face

in balancing the need to reduce their carbon footprint and man-

aging the costs associated with this transition, all while maintain-

ing profitability and fulfilling their tax obligations. The results of

our study raise critical questions about business ethics and the

ongoing debate regarding firms engaging in good or bad business

practices. This is particularly relevant in the context of balancing

environmental responsibilities with financial performance.

Our findings suggest that firms facing higher carbon risk tend

to engage in more tax avoidance practices. This behavior shows

the conflict between short- term financial interests and long-

term sustainability goals, a core issue in business ethics (Carroll

and Shabana2010). On one hand, tax avoidance might be seen

as a rational response to maintain profitability in the face of in-

creasing costs associated with carbon risk management. On the

other hand, it represents a potential overlook of CSR and societal

obligation.

This dichotomy addresses directly the heart of the “good busi-

ness” versus “bad business” debate. Crane and Matten (2021)

argue that truly ethical business practices should align with so-

cietal values and contribute positively to all stakeholders. In this

light, the simultaneous pursuit of environmental responsibility

and tax avoidance could be viewed as contradictory and poten-

tially unethical.

Furthermore, our results contribute to the discussion on the in-

tegration of sustainability and financial objectives in corporate

strategy. Porter and Kramer's(2011) concept of shared value pro-

poses that companies can create economic value in a way that

also produces value for society. However, our findings suggest

that some firms may be failing to fully adopt this approach, in-

stead turning to tax avoidance to offset the costs of environmen-

ta l responsibility.

The ethical implications of this behavior are significant. As

argued by Schaltegger and Burritt (2018), truly sustainable

business models should not rely on externalizing costs to so-

ciety, which could be seen as occurring when firms engage

in tax avoidance. This raises questions about the authenticity

TABLE  | Correlations.

Var iables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

(1) ETR1 1.000

(2) ETR 2 0.157*1.000

(3) C ETR 0.109*0.118*1.000

(4) GHG −0.048*−0.011*−0.009*1.000

(5) GHG a −0.055*−0.007*−0.011*0.880*1.000

(6) I NST 0.033*0.004 −0.005 0.368*0.355*1.000

(7) SIZE 0.154*0.092*0.128*0.030*0.031*0.025*1.000

(8) ROA 0.187*0.125*0.182*−0.018 −0.014 −0.044*0.385*1.000

(9) GEA R −0.032*0.005 −0.012 0.026 0.026*0.027*0.024*−0.176*1.000

(10) B TM −0.065*−0.061*−0.070*0.002 0.028 −0.006 0.102*0.058*−0.309*1.000

(11) CA PEX −0.0 41*−0.036*−0.042*0.003 0.013 −0.002 0.048*0.019 −0.034*0.081*1

(12) BIG 0.009 0.028*−0.004 0.055*0.068*0.021 0.102*0.004 0.007 −0.008 −0.062*1

Note: This t able reports Pearson correlation matrix of our variables.

*Signi ficant at 5% level.

9 of 17

TABLE  | Corporate carbon risk and tax avoidance.

Var iables

ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

GHG −0.141** −0.209** −0.071 −0.132** −0.200** −0.088

(0.066) (0. 089) (0.282) (0 .059) (0.10 2) (0.11)

GHGa −0.130** −0.159** 0.072** −0.151*** −0.152** 0.098**

(0. 053) (0.067) (0. 029) (0.049) (0.067) (0.051)

INST 0.244** 0.107** 0.388*0.124 0.014 −0.242

(0.10 0) (0.0 45) (0.216) (0.101) (0.075) (0.192)

GHG*INST 0.127*** 0.0 74*** 0.242**

(0.011) (0.015) (0.102)

GHGa*INST 0.244** 0.107** 0.387*

(0.110) (0.045) (0.215)

SIZE 0.026** 0.024*** 0.033*** 0.026** 0.017 0.034*** 0.036*** 0.013*** 0.036** 0.035** 0.023** 0.028*

(0.015) (0.0 0 9) (0.011) (0.011) (0.043) (0.010) (0.012) (0.005) (0.017) (0.016) (0.011) (0.016)

ROA 0.128*0.037** 0.161** 0.156** 0.020 0.128*** 0.043** 0.237*0.149*** 0.017 0.167 ** 0.245**

(0.074) (0.015) (0.080) (0.072) (0.102) (0.0 49) (0.018) (0.129) (0.03 8) (0.011) (0.067) (0.119)

GEAR −0.053 −0.068 0.033 −0.049 −0.063 0.012 −0.046 0.015 0.062 −0.094 0.009 0.084

(0.05 4) (0.077) (0.055) (0.062) (0.078) (0 .058) (0.059) (0.06 4) (0.075) (0.100) (0.069) (0.0 94)

BTM −0.027 −0.013 −0.004 −0.037 −0.011 −0.019 −0.030 0.105*0.006 0.042 −0.001 0.042

(0.031) (0.042) (0 .0 28) (0.031) (0 .043) (0. 029) (0.035) (0.062) (0. 03 8) (0.050) (0.033) (0.064)

CAPEX 0.382*1.228** 0.584*0.327 1.177 0.558 0.696 0.960 0.742 0.757 0.442 0.744

(0.207) (0.521) (0.303) (0.479) (0. 544) (0.3 85) (0.453) (0.676) (0.551) (0.558) (0.388) (0.54 8)

BIG 0.034*** 0.100*0.055*0.031** 0.089*0.058*0.028** 0.300** 0.067*0.067 0.017*0.014

(0.012) (0.052) (0.031) (0.012) (0.050) (0 .034) (0.014) (0.123) (0.0 39) (0.043) (0.010) (0.010)

Constant 0.628 0.858** 0.390 0.492*0.487 0.356 0.769*0.100 1.222*0.684 0.048 1.212

(0.392) (0.50 9) (0.462) (0.289) (0.3 41) (0.287) (0. 4 01) (1 .073) (0.6 85) (0.675) (0.596) (1.254)

(Continues)

10 of 17 Strategic Change, 2024

of corporate commitments to sustainability and social

resp on si bi lity.

Moreover, this behavior could be interpreted through the per-

spective of ethical egoism in business, as described by Mihelic,

Lipicni k, and Tekavcic(2010). Firms prioritizing their own inter-

ests through tax avoidance, even while addressing carbon risk,

may be operating under a narrow view of self- interest that fails

to consider the broader societal implications of their actions.

Our findings also enrich the debate surrounding corporate

moral agency (Rönnegard and Velasquez2017). If corporations

are considered moral agents, then the decision to engage in tax

avoidance while managing carbon risk could be seen as a moral

failure, ref lecting a prioritization of financial outcomes over eth-

ical considerations.

These results call for a reevaluation of what constitutes “good

business” in an era of increasing environmental concerns. As

Hoffman (2018) argues, the integration of sustainability into

core business strategy is not just an ethical imperative but a com-

petitive necessity.

In conclusion, our study shows that some companies find it hard

to truly “do business for social good” when they face conflicting

pressures. While these firms try to address environmental is-

sues, they also use tax avoidance tactics that may harm society.

This reveals how difficult it is for businesses to actually work for

social good in the real world, where they often make choices that

help the environment but harm society in other ways.

Now, let's take a look at the moderating role of institutional in-

vestors in the relationship between carbon risk and tax avoidance

(columns (7) to (12) of Table4). The coefficient of the interaction

variable is positive and significant, suggesting that institutional in-

vestors mitigate the adverse effect of carbon risk on tax avoidance.

Therefore, hypothesisH2 is confirmed. Our findings align with

previous studies that emphasized the role of institutional inves-

tors. These findings align with the efficient monitoring hypothesis

(Pound1988) and extend recent research on institutional investors'

role in corporate governance. For instance, the role of institutional

investors aligns with recent research on shareholder activism and

climate change. Flammer, Toffel, and Viswanathan(2021) found

that climate- related shareholder proposals lead to significant re-

ductions in carbon emissions. Our results suggest that institutional

investors' influence extends beyond environmental concerns to in-

volve broader ethical considerations, including tax practices. By

promoting sustainability commitment and encouraging the fight

against carbon risk, institutional investors facilitate the integra-

tion of climate risk management with ethical financial practices.

Furthermore, our results are in line with the growing literature

on the impact of institutional investors on corporate environ-

mental responsibility. Dyck etal. (2019) demonstrated that insti-

tutional investors drive environmental and social performance

improvements, especially in countries with weak social norms.

Our findings extend these findings by showing that institutional

investors not only encourage better environmental practices but

also promote responsible tax behavior in the face of carbon risk.

Thus, our findings contribute to the literature on corporate sus-

tainability (Guthrie, Manes- Rossi, and Orelli2017), showing how

external stakeholders can drive the alignment of environmental,

Var iables

ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

Industry fixed effects Yes Yes Ye s Yes Yes Yes Ye s Yes Ye s Yes Yes Ye s

Year fixed effects Yes Yes Ye s Ye s Yes Yes Ye s Yes Ye s Yes Yes Yes

Obs. 6595 6595 6595 6595 6595 6595 6595 6595 6595 6595 6595 6595

N854 854 854 854 854 854 854 854 854 854 854 854

Note: This t able shows the instrumental variable regression results of corporate tax avoidance on carbon risk and control var iables. See variable definitions in AppendixA. A ll the continuous variables are winsorized at the 1st and

99th percentiles.

***Significant at 1% level.

**Significant at 5% level.

*Signi ficant at 10% level.

TABLE  | (Continued)

11 of 17

TABLE  | Robustness checks.

Var iables

ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

GHG −0.384** −0.211*** −0.487**

(0.153) (0.051) (0 .241)

GHGa −0.180** −0.149** −0.439***

(0.079) (0.071) (0.129)

INST 0.369*** 0.276*** 0.314** 0.298 0.532 0.366

(0.12 8) (0.085) (0.145) (0.578) (0 .499) (0.421)

GHG*INST 0.369*** 0.276*** 0.318**

(0.111) (0.097) (0.147)

GHGa*INST 0.228*** 0.682*** 0.520***

(0. 073) (0.219) (0.147)

SIZE 0.407** 0.143** 0.150 0.298** 0.171*0.167*** 0.214*0.074** 0.102** 0.258*0.189** 0.402***

(0.186) (0.058) (0.109) (0.116) (0.09 8) (0.053) (0 .101) (0.0 33) (0 .04 8) (0.138) (0.078) (0.12 1)

ROA −0.053 0.040 0.046 −0.056 0.020 0.005 −0.032 0.049 0.019 −0.016 −0.092 0.306

(0.101) (0.062) (0.095) (0.071) (0.058) (0. 098) (0.0 89) (0.0 65) (0.07 3) (0.089) (0.117) (0.609)

GEAR −0.157*−0.038 −0.049 −0.079 −0.032 −0.031 −0.113 −0.046 −0.030 −0.048 −0.021 0.502

(0.0 91) (0.029) (0. 05 4) (0.058) (0.027) (0.05 4) (0.0 78) (0.037) (0.041 (0.072) (0.080) (1.0 43)

BTM −0.165 −0.208 0.434 0.024 −0.179 0.502 0.171 −0.027 0.232 0.111 0.302 0.662

(0.871) (0.387) (0.571) (0.652) (0.3 48) (0. 63 4) (0.866) (0.387) (0.511) (0.639) (0.710) (0.475)

CAPEX 0.213** 0.089** 0.086** 0.128*0.059** 0.115*0.263*0.078** 0.081*0.096*0.235*(0.612**

(0.0 61) (0.0 42) (0.043) (0.066) (0.028) (0.0 60) (0.148) (0 .038) (0.045) (0.050) (0.129) (0.321)

BIG 0.441*** 0.536*** 0.208** 0.326*** 0.534** 0.232*0.375** 0.675*** 0.453** 0.230** 0.463*** 0.248

(0.152) (0 .161) (0.091) (0.077) (0.2 53) (0.1 38) (0.170) (0.249) (0.224) (0.111) (0.137) (0.159)

Constant 0.565 0.875*0.397 0.508*0.512 0.370 0.78 4*0.104 1.246*0.698 0.049 0.970

(0.38 4) (0.526) (0.4 4 8) (0.294) (0.347) (0.292) (0.409) (1.095) (0.699) (0. 689) (0.6 08 (1.279)

(Continues)

12 of 17 Strategic Change, 2024

social, and governance factors in corporate decision- making. The

influence of institutional investors in our study also relates to the

concept of ‘ethical leadership’ in business, as discussed by Brown

and Treviño (2006). By encouraging firms to manage carbon risk

without relying on tax avoidance, these investors are effectively

promoting ethical decision- making at the highest levels of corpo-

rate governance. Also, our findings provide empirical evidence for

the positive role that institutional investors can play in promoting

ethical business practices. By encouraging firms to manage carbon

risk responsibly while discouraging tax avoidance, these investors

are helping to reduce the gap between environmental responsibil-

ity and fiscal ethics. This aligns with the growing recognition, as

noted by Schaltegger and Burritt(2018), that truly sustainable and

ethical business models must integrate social, environmental, and

economic considerations. Our results suggest that institutional in-

vestors are becoming key drivers of what Hoffman(2018) terms

‘good business’- practices that balance profitability with social and

environmental responsibility. By discouraging tax avoidance in the

face of carbon risk, these investors are pushing firms to address

environmental challenges without relying on ethically uncertain

financial strategies. These results lie at the core of the ‘good vs.

bad business practices’ debate. While tax avoidance might be seen

as a rational response to financial pressures from carbon risk, it

represents what Palazzo and Scherer (2006) describe as a ‘bad’

business practice that prioritizes short- term gains over long- term

societal welfare. Institutional investors, by discouraging such be-

havior, are effectively promoting ‘good’ business practices that

consider both environmental and fiscal responsibilities.

These findings offer valuable insights into how institutional

investors play a pivotal role in promoting good business prac-

tices. They encourage firms to aim for higher standards of sus-

tainability while simultaneously exerting pressure to minimize

behaviors such as tax avoidance. This dual influence aligns

with the concept of ‘responsible ownership’ proposed by Kölbel

etal.(2020), where investors actively engage with firms to im-

prove both financial and social performance.

5.3 | Robustness Check

Given that our study period covers both the year of the Paris

Agreement on climate sign (2015) and the period of the

COVID- 19 pandemic, we re- estimate our model by excluding

these specific years, namely 2015 and the years 2020 and 2021

(during the COVID- 19 pandemic). By excluding these years

from the analysis, our aim is to isolate a period unaffected by

these crises and evaluate the robustness and consistency of our

conclusions. The results, displayed in Table5, confirm our main

findings.

6 | Conclusion

The aim of this study is to examine the effect of carbon risk on

tax avoidance as moderated by institutional shareholders. Based

on a sample of 854 US firms from 2015 to 2022, a 2SLS regression

using instrumental variables is applied. The findings provided

empirical evidence of the significant impact of carbon risk on

tax avoidance. The findings show that higher levels of carbon

risk are associated with increased tax avoidance strategies and

Var iables

ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR ETR1 ETR2 CETR

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

Industry fixed effects Yes Yes Yes Yes Yes Yes Yes Ye s Ye s Yes Yes Ye s

Year fixed effects Yes Yes Yes Yes Yes Yes Yes Ye s Ye s Yes Yes Ye s

Obs. 4135 4135 4135 4135 4135 4135 4135 4135 4135 4135 4135 4135

N854 854 854 854 854 854 854 854 854 854 854 854

Note: This t able shows the instrumental variable regression results of corporate tax avoidance on carbon risk and control var iables while excluding the year of the Paris Agreement signing (2015) and the period of the COVID- 19

pandemic. See variable def initions in AppendixA. All the continuous variables are winsorized at the 1st and 99th percentiles.

***Significant at 1% level.

**Significant at 5% level.

*Signi ficant at 10% level.

TABLE  | (Continued)

13 of 17

institutional investors weaken this relationship. Our evidence

does not diminish the value of carbon risk management but

highlights the need for a stronger commitment to sustainabil-

ity to optimize its effects on firm decisions, particularly in fiscal

matters.

6.1 | Implications for Theory and Practice

This study makes significant theoretical contributions within the

framework of “What Makes Business Good? and Organizing for

Social Good.” Specifically, it extends agency theory by illustrating

how managers' incentives to maximize short- term profits may

lead to tax avoidance behavior in response to pressures to reduce

carbon risk. By highlighting the importance of considering man-

agement incentives when formulating corporate environmental

and tax policies, the research emphasizes the necessity of aligning

business strategies with broader societal goals. Furthermore, the

study suggests that institutional investors, acting as gatekeepers,

can play a crucial role in mitigating opportunistic behavior by

monitoring and pressuring management to adopt more respon-

sible practices. This enriches agency theory by highlighting the

role of institutional investors as a counterweight to the interests of

CEOs and promoting corporate practices that prioritize environ-

mental sustainability and ethical governance. The findings con-

tribute also to the ongoing discussion about the role of external

stakeholders in shaping corporate ethics. Specifically, this study

contribute to the discussion about the effectiveness of institu-

tional ownership in promoting responsible business practices and

offers new insights into the interaction between environmental

risk management and corporate tax behavior. In terms of legit-

imacy theory, the study contributes by emphasizing the impor-

tance of stakeholder perception, including that of investors, in

managing environmental and fiscal risks. By demonstrating that

the reduction of carbon risk can be driven by the need to maintain

corporate legitimacy, the research expands our understanding of

how companies seek to meet stakeholder expectations to main-

tain their social acceptability. Moreover, by highlighting the role

of institutional investors in mitigating tax avoidance behavior, the

study enriches legitimacy theory by illustrating how external ac-

tors can influence corporate practices to ensure long- term legiti-

macy and contribute to societal well- being.

Practically, this study offers essential implications. First, stake-

holders need to exercise caution when assessing whether firms

are doing good or bad in managing carbon risk, considering the

substantial influence of carbon risk on tax avoidance. Therefore,

stakeholders should critically evaluate the alignment of carbon

risk management strategies with fair fiscal practices, promoting

financially responsible behaviors and distinguishing between

good and bad business practices. Second, companies should pri-

oritize increased transparency in financial and tax reporting to

demonstrate whether they are engaging in good or bad business

practices. Proactive disclosure of tax and environmental policies

and practices can enhance stakeholder confidence and mitigate

reputational risk, contributing to the promotion of organizing for

social good. Third, boards of directors must strengthen their over-

sight and governance to ensure effective management of climate

change and tax compliance risks, thus promoting good business

practices. This involves closer monitoring of sustainability and tax

compliance policies and practices, alongside the implementation

of appropriate control mechanisms, fostering ethical practices

and reducing the likelihood of engaging in bad business practices.

Fourth, institutional investors should intensify their commitment

with companies to promote sustainable and responsible practices,

thereby encouraging good business practices. By actively engag-

ing with companies to understand their sustainability and tax

compliance concerns and expectations, institutional investors can

discourage bad business practices and incentivize the adoption of

environmentally conscious and financially responsible strategies.

Lastly, this study may have significant political implications as pol-

icymakers may be prompted to review tax and environmental poli-

cies to address both good and bad business practices. Policymakers

can respond to increased pressure by reforming the tax system to

reduce incentives for bad business practices such as tax avoidance,

while encouraging sustainable practices. Additionally, they could

support initiatives to encourage responsible engagement by insti-

tutional investors, potentially through the creation of tax or reg-

ulatory incentives for investors integrating environmental social

and governance criteria into their investment decisions.

6.2 | Study Limitations and Future Research

Suggestions

Although this study examined a large sample of US firms and

considered the significant role of institutional investor owners,

one of the most important shareholders in the U.S. context, it

has some limitations. First, the current study uses a composite

measure of tax avoidance. Future research could conduct in-

teresting extensions by disaggregating the measures into more

specific components that could offer a deeper understanding of

corporate tax avoidance practices. For example, it would be bene-

ficial to break down the current tax rate into several components,

such as corporate income taxes, tax credits, and tax deductions,

to identify specific sources of tax avoidance. Similarly, break-

ing down total tax expenditure into different components, such

as income taxes, value- added taxes, and property taxes, could

help identify specific areas where companies seek to minimize

their tax exposure. Second, to enrich our analysis and examine

whether the relationship between carbon risk and tax avoidance

differs for polluting firms (such as energy and utility firms) com-

pared to less polluting ones. Third, while this study focuses on

the linear relationship between carbon risk and tax avoidance,

future studies could explore nonlinear relationships to elucidate

how firms balance sustainability objectives and ethical tax be-

havior. Finally, other than institutional investors ownership, sev-

eral other factors might play a role in moderating carbon risk and

tax avoidance, such as board monitoring.

Conflicts of Interest

The authors declare no conflicts of interest.

Data Availability Statement

The data that support the findings of this study are available from the

corresponding author upon reasonable request.

Endnotes

1 Deloitte, PricewaterhouseCoopers, Ernst & Young, and K PMG.

14 of 17 Strategic Change, 2024

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Appendix A

Variable Definitions

Var ia ble s Acronym Definition

Dependent variables

Tax avoidance ETR1 Current income tax expense scaled by pretax accounting income.

ETR2 Tax expenses scaled by operational cash flows.

CETR Taxes paid scaled by pretax accounting income minus special items

Independent variables

GHG intensity GHG Direct and First Tier indirect GHG emissions are divided by the firm's revenues.

Absolute GHG emissions GHGa Direct and First Tier indirect GHG emissions over the firm's control.

Moderating variables

Institutional investor INST Percentage of share owned by the five largest institutional investors.

Control variables

Firm size SIZE The natural logarithm of total assets.

Return on assets ROA Net income divided by total assets.

Firm leverage GEAR The total debt scaled by total assets.

Book to market ratio BTM Firm's book value to market value.

Capital expendit ures CAPEX Capital expenditures to total assets.

Audit qualit y BIG A binary variable takes 1 when the firm is audited by a BIG4 and zero,

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