Against this background, this volume is the first to present a fully-fledged overview of the interdependence of tax and corporate governance. Not only the basic political, legal and economic questions but also major topics like income measurement, shareholding structures, corporate social responsibility and tax shelter disclosure are covered.
Product details Format Paperback pages Dimensions x x Other books in this series. Add to basket. Intellectual Property in Asia Peter Ganea. Geistiges Eigentum Reto Hilty. Back cover copy The interaction of tax and corporate governance forms an emerging issue both in business and administrative practice and in academic research.
International organisations OECD, EC have begun to explore the effects corporate governance rules exert on the tax policy of large business; governments try to employ corporate and securities law as a means to further their fiscal interest. Academic research shows that well-known principal-agent and capital market problems are strongly influenced by tax considerations. Not only the basic political, legal and economic questions but also major topics like income measurement, shareholding structures, corporate social responsibility and tax shelter disclosure are covered extensively by leading authors.
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How representative is such a transaction in depicting what motivates corporate tax shelters? Bankers Trust, the advisor to Enron on this transaction, initially showed a variant on the final structure that did not provide financial accounting benefits. Desai and Dharmapala b provide a more general stylized example of how earnings manipulation goals can be facilitated by tax shelters.
The wider theme here is that tax shelters may provide diversionary opportunities through obfuscation that is easily rationalized as tax avoidance, as in the Sibneft example in Desai, Dyck, and Zingales These interactions between avoidance decisions and managerial misbehavior are the critical grounding of the agency perspective on tax avoidance. Empirical Evidence The corporate governance view of taxation yields three distinct predictions that can be tested in various settings.
First, characteristics of a tax system — such as the structure of rates and the nature of enforcement — will influence managerial actions and hence the extent of the agency problem. Second, the nature of the corporate governance environment — e. Third, tax avoidance need not represent a simple transfer of resources from the state to shareholders; rather, managers may capture a share of the benefits of tax avoidance. The first two of these predictions have been evaluated in the international setting with particular emphasis on developing countries while the third has been evaluated using U.
Their model predicts that increases in corporate tax rates should lead to larger revenue increases in countries with stronger corporate governance institutions. This hypothesis is tested using data on a panel of countries with differing corporate governance institutions. As predicted, corporate tax rate increases lead to increased revenues only in countries with strong corporate governance.
For countries with weak corporate governance, the estimates suggest that revenues decline with higher tax rates, because of the interactions with the corporate governance system. The model of Desai, Dyck, and Zingales also predicts that tax enforcement may benefit shareholders if the resulting decline in diversion by insiders is sufficiently large to offset the direct loss of shareholder value due to increased tax payments. They find that firms targeted by these enforcement efforts experienced an increase in market value, and that the voting premia for these firms a proxy for private benefits of control declined.
To comply with the law, they have to declare higher profits and pay higher taxes. They must also show the true extent of their financial operations to outside shareholders, who are just as keen to have a share of the proceeds as the tax inspector. This evidence is hard to reconcile with traditional views of tax avoidance.
Tax and Corporate Governance
Evidence on Tax Avoidance in the U. While the international evidence discussed above may seem far removed from the developed country setting, an emerging literature has found significant interactions between taxation and corporate governance in the U. These empirical investigations are of course hampered by the difficulty of measuring tax avoidance. However, because tax returns are confidential, the book-tax gap is not directly observable to most researchers or to investors. While there are a number of important caveats to this approach reviewed e.
Moreover, this measure has the distinct advantage of being observable to investors. However, book-tax gaps may be due to factors other than tax avoidance; in particular, they may reflect earnings management i.
Tax and corporate governance /
In order to incorporate the effects of earnings management, Desai and Dharmapala a implement a procedure that seeks to correct the book-tax gap for the influence of earnings management. The approach developed in Desai and Dharmapala a isolates the component of the estimated book-tax gap that is not explained by accruals or abnormal accruals.
While the sample of firms involved in litigation is small, this provides some reassurance that the proxy is correlated with tax avoidance activity. In order to test the implications of the agency model discussed above, this measure of tax avoidance can be related to the nature of managerial incentives and to market values to understand how markets value tax avoidance. Desai and Dharmapala a present a simple model in which the impact of greater incentive-alignment between shareholders and managers has an ambiguous effect on the extent to which managers undertake tax avoidance activities.
On the one hand, higher-powered incentives create a direct motivation to increase after-tax firm value, and hence to increase tax avoidance. On the other hand, higher-powered compensation schemes dissuade managers from acts of opportunism that may be complementary with tax sheltering. In turn, this induces managers to reduce tax avoidance activity as well. For example, consider a manager who can use a tax shelter to not only reduce tax obligations, but also to manipulate financial reporting to move earnings into the current period, and sell stock in the firm at temporarily higher prices.
Given this ambiguity, the effect of managerial incentives on tax avoidance is an empirical question. The results presented in Desai and Dharmapala a indicate a negative relationship between their incentive compensation and tax avoidance measures. This negative relationship contradicts the straightforward view of corporate tax avoidance as simply a means of reducing tax obligations, but is consistent with managerial opportunism being an important consideration and with the existence of complementarities between tax avoidance and managerial opportunism.
Moreover, this view is supported by further analysis that focuses on the differences in the governance 3 This sample of firms was first identified and studied by Graham and Tucker However, the number of firms involved in such litigation is small, and so their measure of tax sheltering activity is not suitable for a large-sample approach. In a related paper, Desai and Dharmapala c investigate the effects of their proxy for tax avoidance on firm valuation.
Specifically, tax avoidance should lead to larger increases in firm value at better- governed firms. This is not simply because of a tendency among managers of poorly- governed firms to waste or dissipate a larger share of any value-generating activity they may engage in, but also because complex and obfuscatory tax avoidance activities create a potential shield for managerial opportunism, and this factor will naturally loom larger at firms where governance institutions are weaker.
This result is robust to the use of a wide variety of controls and various extensions to the model. It also holds when a change in tax regulations that apparently reduced the costs of tax avoidance for a subsample of firms is used as a source of exogenous variation in tax avoidance activity. Other evidence The emerging literature on the corporate governance view of taxation has begun to receive support more broadly from a variety of studies.
These studies come in two varieties. For example, Hanlon and Slemrod study market reactions to news reports about tax sheltering activity by corporations.
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However, the reaction is more positive for better-governed firms, which is consistent with the theoretical framework developed in 4 Governance characteristics are measured using the index constructed by Gompers, Ishii and Metrick and by a measure of the extent of institutional ownership.
Similarly, Desai and Hines study market reactions to corporate expatriations or inversions — transactions in which a US parent corporation becomes the subsidiary of its former tax haven subsidiary through a share swap. The second type of evidence relates to the role of the IRS as a meaningful monitor of managerial misbehavior.
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Erickson, Hanlon and Maydew analyze a sample of firms that were found by the SEC to have fraudulently overstated earnings. They find that these firms paid a significant amount of taxes on these fraudulent earnings. This suggests that, at least for this sample of firms, the threat of IRS monitoring of their taxable income loomed larger than did investor monitoring of their financial statements. Similarly, Guedhami and Pittman find evidence that debt financing is cheaper when the probability of a face-to-face IRS audit is higher.
The role of IRS oversight on debt financing costs is also related to the ownership structure of firms and the presumed agency costs of those arrangements. Thus, managers and investors appear to appreciate the role of a tax enforcement agency as a monitor of managerial opportunism. Mechanisms to Address the Agency Problem The extant literature has emphasized the role of taxes in influencing the nature of managerial misbehavior.
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However, the role of taxes in shaping the various mechanisms that constitute the overall corporate governance environment has been neglected. To take one example, ownership patterns such as concentrated ownership can ameliorate one type of agency problem and give rise to another.
The role of taxes in shaping ownership patterns can then have corporate governance implications. Similarly, corporate governance environments can lead to particular ownership structures such as the pyramidal form that can then modify the impact of tax policy. Ownership Patterns As discussed above, ownership patterns may change in response to problems created by the broader corporate governance environment. Indeed, in much of the world, the most common solution to the agency problem is for large shareholders to own controlling stakes in firms, thereby giving them both the incentive and opportunity to monitor managers.
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