Corporate Tax Avoidance and Corporate Social Responsibility Disclosure Readability: Evidence from China

Abstract

Paying taxes to support the societies in which they operate is both a legal and ethical responsibility of business. Nevertheless, some companies work to avoid taxes, which could cause society to question the legitimacy of the organisation. Many companies provide reports on their corporate social responsibility (CSR) activities; more transparent CSR reports may help to restore the legitimacy loss associated with tax avoidance. We investigate the relationship between tax avoidance and CSR report readability among Chinese companies. We find a positive relationship between corporate tax avoidance and the readability of CSR reports. This relation is weaker among state-owned enterprises, which may have stronger pre-existing legitimacy owing to their relationship with the state. The relationship is also weaker among companies in less developed regions of China, which have less developed institutions to monitor organisational legitimacy. Overall, our results are consistent with the notion that CSR reporting represents an attempt to overcome legitimacy concerns arising from tax avoidance. Our findings indicate that tax avoidance and CSR reporting are alternative means of establishing legitimacy, rather than complementary reflections of an organisational culture that values (or devalues) CSR.Corporate social responsibility (CSR) refers to the actions designed by companies to improve their social and environmental conditions (Mackey et al. 2007). One aspect of CSR is a company's willingness to pay taxes to promote social welfare. If a company avoids paying its 'fair share' of taxes, the company can be considered a 'poor citizen' (Bankman 2004), and viewed as socially irresponsible (Huseynov and Klamm 2012). Avoiding taxes can therefore deviate from social expectations, reducing the trust of stakeholders and endangering corporate legitimacy (Lanis and Richardson 2013). CSR reporting may be a solution for managers to maintain (or regain) legitimacy among stakeholders (Bebbington et al. 2008;Chen et al. 2016) when they are avoiding taxes.Disclosure by management of CSR activities has drawn attention in both research and practice (i.e., Dhaliwal et al. 2011;Lys et al. 2015;Chen et al. 2018). CSR reporting can reduce information asymmetry and build stakeholder trust (Kim et al. 2012). More readable CSR reporting can help firms improve their communication with stakeholders about their legitimacy and compliance with social norms by using clear, plain and understandable language (Zhang et al. 2021). Zhang et al. (2021) also found that the reputational damage caused by financial restatements can be at least partially restored by more readable CSR reports. If the reputational damage from financial restatements can be offset by enhanced CSR readability, managers may perceive that the adverse effect of tax avoidance on corporate legitimacy can also be offset by more readable CSR reports. In this 'legitimacy gap' perspective, paying a fair share of taxes or providing transparent CSR disclosure could be alternative/substitute means for c...

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