Incentives for Tax Planning and Avoidance: Evidence from the Field

Abstract

ABSTRACT: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% 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% 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% of public firms say that increasing earnings per share is an important outcome from a tax planning strategy.

Corporate Governance, Tax Avoidance, and Financial Constraints

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We examine how corporate governance affects the relationship between corporate tax avoidance and financial constraints. 2 The survey evidence of Graham et al (2014) suggests that financially constrained firms are more likely to manage their taxes to obtain cash savings. In firms with strong governance, however, we find that tax avoidance does not have a negative impact on financial constraints.

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“…While outside investors may recognize tax management as a value-increasing activity for a financially constrained firm, more aggressive tax avoidance practices may also be associated with increased opportunities for rent diversion by the firm's managers. In addition to direct costs of tax planning (administrative costs, litigation expenses, and penalties imposed by tax authorities), aggressive tax avoidance activities, such as tax sheltering, may involve substantial indirect costs including potential reputation losses, political costs, a greater cost of debt, and a higher stock price crash risk (Hanlon and Slemrod, 2009;Wilson, 2009;Kim, Li, and Zhang, 2011;Graham et al, 2014;Hasan et al, 2014). Because tax avoidance usually implies the need to engage in actions that obscure the underlying intent of the transaction, it can simultaneously provide a shield for managers engaging in a variety of diversionary activities that increase their payouts at the expense of shareholders.…”

Tax avoidance in different firm types and the role of nonfamily involvement in private family firms

“…Consequently, managers of public firms are generally concerned about the stock market reaction to reported financial earnings (Penno & Simon, ). In an analysis of survey responses, Graham et al () show that 57% of public firms state that rising net earnings per share is an important result of a tax strategy.…”

“…Thus, it is unclear whether other tax avoidance proxies (e.g., cash ETR or long‐run GAAP ETR) may lead to different takeaways in private firms. Specifically, a survey by Graham, Hanlon, Shevlin, and Shroff () indicates that public firms attach greater importance to the GAAP ETR, whereas private firms focus more on the cash ETR. Therefore, we hand‐collect data on cash taxes paid by private firms to analyze a broader spectrum of tax avoidance, thereby contributing to the abovementioned discussion.…”

Tax avoidance and ex ante cost of capital

“…Graham, Hanlon, Shevlin, and Shroff () report that 69% of surveyed executives do not undertake additional tax avoidance because of reputational concerns that they may be labeled a ‘poor corporate citizen’ (Bankman, ), which may adversely affect their firm's image or product brand. Based on their survey results, it appears that corporate executives are concerned about the adverse reaction from investors and consumers if the firm is too aggressive in its tax‐avoidance activities.…”