The corporate governance of profit shifting

Delis, Manthos and Karavitis, Panagiotis and Klassen, Kenneth (2018): The corporate governance of profit shifting.

Abstract

Tax-motivated profit shifting is an increasingly important element in the agenda of academics and policy-makers in the effort to understand tax-planning behavior and to promote tax fairness. In this research, we view profit shifting as the outcome of corporate governance characteristics of multinational enterprises (MNEs), ceteris paribus. Using a sample of 860 parent firms from 24 countries, 6,698 subsidiaries in 49 countries, we first measure profit shifting from the responses of subsidiary profits to parent earnings shocks. We draw on several agency theories of the firm and we show that elements of board structure, directors’ experience and networks, and CEO duality have an economically important influence on the aggressiveness of profit shifting. Using our baseline specification, a one-standard deviation change in these board characteristics implies an 11.06% total response in our measure of profit shifting.

• Item Type: MPRA Paper
• Language: English
• Keywords: Profit shifting; Corporate governance; Board structure; Directors’ experience; CEOvduality
• Subjects: F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms ; International Business; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H25 - Business Taxes and Subsidies; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H26 - Tax Evasion and Avoidance; H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents > H32 - Firm; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting

References

Adams, R. B., Almeida, H., Ferreira, D., 2005. Powerful CEOs and their impact on corporate performance. Review of Financial Studies 18, 1403–1432.

Agrawal, A., Chadha, S., 2005. Corporate governance and accounting scandals. Journal of Law and Economics 48, 371–406.

Armstrong, C., Blouin, J., Jagolinzer, A., Larcker, D., 2015. Corporate governance, incentives, and tax avoidance. Journal of Accounting and Economics 60, 1–17.

Bacon, J., Brown, F., 1973. Corporate directorship practices: role, selection, and legal status of the board. New York: The Conference Board, Inc.

Beasley, M., 1996. An empirical analysis of the relation between the board of director composition and financial statement fraud. The Accounting Review 71, 443–465.

Beasley, M.S., Carcello, J.V., Hermanson, D.R., Lapides, P.D., 2000. Fraudulent financial reporting: consideration of industry traits and corporate governance mechanisms. Accounting Horizons 14, 441–454.

Bertrand, M., Mehta, P., Mullainathan, S., 2002. Ferreting out tunneling: an application to Indian business groups. Quarterly Journal of Economics 117, 121–148.

Bhagat, S., Black, B., 1999. The uncertain relationship between board composition and firm performance. Business Lawyer 55, 921–963.

Bird, A., Karolyi, S., 2017. Governance and taxes: Evidence from regression discontinuity. The Accounting Review 92, 29–50.

Blaylock, B. S. (2016). Is tax avoidance associated with economically significant rent extraction among US firms?. Contemporary Accounting Research, 33(3), 1013-1043.

Blundell, R., Bond, S., 1998. Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics 87, 115–143.

Booth, H., Deli, D., 1995. Factors affecting the number of outside directors held by CEOs. Journal of Financial Economics 40, 81–104.

Brown, J., 2011. The spread of aggressive corporate tax planning: A detailed examination of the corporateowned life insurance shelter. The Accounting Review 86, 23–57.

Brown, J., Drake, K., 2014. Network ties among low-tax firms. The Accounting Review 89, 483–510.

Budd, J. W., Konings, J., Slaughter, J., 2005. Wages and international rent sharing in multinational firms. The Review of Economics and Statistics 87, 73–84.

Burt, R. S., 1992. Structural Holes. Cambridge, MA: Harvard University Press.

Celikyurt, U., Sevilir, M., Shivdasani, A., 2014. Venture capitalist on boards of mature public firms. Review of Financial Studies 27, 56–101.

Centre for Tax Policy and Administration, 2009. General Administrative Principles: Corporate governance and tax risk management. Tax guidance series. (Available at) https://www.oecd.org/tax/administration/43239887.pdf

Chen, G., Firth, M., Gao, D.N., Rui, O., 2006. Ownership structure, corporate governance, and fraud: evidence from China. Journal of Corporate Finance 12, 424–448.

Coleman, J. S., 1988. Social capital in the creation of human capital. The American Journal of Sociology 94, 95–120.

Coles, J., Daniel, N., Naveen, L., 2008. Boards: does one size fit all? Journal of Financial Economics 87, 329–356.

Correia, S., 2015. Singletons, cluster-robust standard errors and fixed effects: a bad mix. Working Paper.

Dechow, P.M., Sloan, R.G., Sweeney, A.P., 1996. Cases and consequences of earnings manipulations: an analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research 13, 1–36.

Deli, D., Gillan, S., 2000. On the demand for independent and active audit committees. Journal of Corporate Finance 6, 427–445.

Deloitte, 2015. Keeping pace with tax change: A briefing for non-executives. Governance in focus. Available at https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/audit/ deloitte-uk-governance-in-focus-keeping-pace-with-tax-change-jan-2015.pdf

Desai, M., Dharmapala, D., 2006. Corporate tax avoidance and high-powered incentives. Journal of Financial Economics 79, 145–179.

Desai, M. A., & Dharmapala, D. (2009). Corporate tax avoidance and firm value. The review of Economics and Statistics, 91(3), 537-546.

Desai, M. A., Dyck, A., & Zingales, L. (2007). Theft and taxes. Journal of financial economics, 84(3), 591- 623.

Devereux, M.P., Maffini, G., 2007. The impact of taxation on the location of capital, firms and profit: a survey of empirical evidence. Oxford University Centre for Business Taxation Working Paper Series, WP 07/02, Said Business School, Oxford.

Dharmapala, D., Riedel, N., 2013. Earnings shocks and tax-motivated income-shifting: evidence from European multinationals. Journal of Public Economics 97, 95–107.

Dyreng, S., Hoopes, J., Wilde, J., 2016. Public pressure and corporate tax behavior. Journal of Accounting Research 54, 147–186.

Efron, B., Tibshirani, R., 1993. An introduction to the bootstrap. New York: Chapman and Hall.

Fama, E., 1980. Agency problems and the theory of firms. Journal of Political Economy 88, 288–307.

Fama, E., Jensen, M., 1983. The separation of ownership and control. Journal of Law and Economics 26, 301–325.

Fich, E., M., Shivdashani, A., 2006. Are busy boards effective monitors? Journal of Finance 61, 689–724.

Francis, B., Hasan, I., Park J. C., Wu, Q., 2015. Gender differences in financial reporting decision making: evidence from accounting conservatism. Contemporary Accounting Research 32, 1285–1318.

Gul, F.A., Srindhi, B., Tsui, J. S. L., 2008. Board diversity and the demand for higher audit effort. Working Paper, http://ssrn.com/paper=1359450S.

Hambrick, D., Fukutomi, G., 1991. The seasons of a CEO‘s tenure. The Academy of Management Review 16, 719–742.

Hasan, I., Hoi, C. K. S., Wu, Q., & Zhang, H. (2014). Beauty is in the eye of the beholder: The effect of corporate tax avoidance on the cost of bank loans. Journal of Financial Economics, 113(1), 109-130.

Hines, J.R., Rice, E.M., 1994. Fiscal paradise: foreign tax havens and American business. Quarterly Journal of Economics 109, 149–182.

Huang, S., 2013. Zombie board: board tenure and firm performance. INSEAD working paper.

Jensen, M., 1993. The modern industrial revolution, exit, and the failure of internal control systems. Journal of Finance 48, 831–880.

Jensen, M., Meckling, W. H., 1976. Theory of the firm: managerial behavior, agency costs, and ownership structure. Journal of Financial Economics 3, 303–360.

Kim, J. B., Li, Y., & Zhang, L. (2011). Corporate tax avoidance and stock price crash risk: Firm-level analysis. Journal of Financial Economics, 100(3), 639-662.

Klassen, K. J., Laplante, S.K., 2012. Are U.S. multinational corporations becoming more aggressive income shifters? Journal of Accounting Research 50, 1245–1285.

Klein, A., 2002. Audit committee, board of director characteristics, and earnings management. Journal of Accounting and Economics 33, 375–400.

Lambe, M., 2015. BEPS – The impact in the Boardroom? Available at: http://ceo-insight.com/treasury-andtax- management/250-beps-the-impact-in-the-boardroom.

Larcker, D.F., Tayan, B., 2016. Chairman and CEO. The controversy over board leadership structure. Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-58, Stanford University.

Lennox, C., Lisowsky, P., & Pittman, J. (2013). Tax aggressiveness and accounting fraud. Journal of Accounting Research, 51(4), 739-778.

Li, Q., Maydew, E., Willis, R., & Xu, L. (2017). Taxes and Director Independence: Evidence from Board Reforms Worldwide. University of North Carolina working paper.

Lo, A., Wong, R., Firth, M., 2010. Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. Journal of Corporate Finance 16, 225–235.

Masulis, R., Wang, C., Xie, F., 2012. Globalizing the boardroom–The effects of foreign directors on corporate governance and firm performance. Journal of Accounting and Economics 53, 527–554.

Markle, K., 2016. A comparison of the tax-motivated income shifting of multinationals in territorial and worldwide countries. Contemporary Accounting Research 33, 7–43.

McMullen, D.A., 1996. Audit committee performance: an investigation of the consequences associated with audit committees. Auditing: A Journal of Practice and Theory 16, 87–103.

Minnick, K., Noga, T., 2010. Do corporate governance characteristics influence tax management? Journal of Corporate Finance 16, 703–718.

Misutka, D., MacEachern, L., 2013. The CRA’s tax transparency initiatives: Implications for a corporate governance response. Canadian Tax Journal 61, 829–855.

Nahapiet, J., Ghoshal, S., 1998. Social capital, intellectual capital, and the organizational advantage. Academy of Management Review 23, 242–266.

Oh, H., Labianca, G., Chung, M. H., 2006. A multilevel model of group social capital. Academy of Management Review 31, 569–582.

Peasnell, K. V., Pope, P. F., Young, S., 2005. Board monitoring and earnings management: do outside directors influence abnormal accruals? Journal of Business Finance and Accounting 32, 1311–1346.

Pennings, J. M., Lee, K., Witteloostuijn A., 1998. Human capital, social capital, and firm dissolution. Academy of Management Journal l4, 425–440.

Rego, S. O., & Wilson, R. (2012). Equity risk incentives and corporate tax aggressiveness. Journal of Accounting Research, 50(3), 775-810.

Seidman, J. K., & Stomberg, B. (2017). Equity compensation and tax avoidance: Disentangling managerial incentives from tax benefits and reexamining the effect of shareholder rights. The Journal of the American Taxation Association, 39(2), 21-41.

Slemrod, J., 2004. The economics of corporate tax selfishness. National Tax Journal 57, 877–899.

Uzun, H., Szewczyk, S.H., Varma, R., 2004. Board composition and corporate fraud. Financial Analysts Journal 60, 33–43.

Van den Berghe, L. A. A., Levrau, A., 2004. Evaluating boards of directors: what constitutes a good corporate board? Corporate governance: An International Review 12, 461–478.

Weisbach, M., 1988. Outside directors and CEO turnover. Journal of Financial Economics 20, 431–460.

Windmeijer, F., 2005. A finite sample correction for the variance of linear efficient two-step GMM estimators. Journal of Econometrics 126, 25–51.

Wintoki, M. B., Linck, S.J., Netter, M.J., 2012. Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics 105, 581–606.

Wilde, J., and R. Wilson, 2017. Perspectives on corporate tax planning: Observations from the past decade. University of Iowa working paper.

Wu, S., Levitas, E., Priem, R. L., 2005. CEO tenure and company invention under differing levels of technological dynamism. Academy of Management Journal 48, 859–873.

Yermack, D., 1996. Higher market valuations of companies with a small board of directors. Journal of Financial Economics 40, 185–211.