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Voluntary disclosure, tax avoidance and family firms

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Abstract

This study examines the effect of voluntary disclosure in annual reports on tax avoidance activities. The agency theory of tax avoidance suggests that tax sheltering is associated with important agency costs, underlining the importance of corporate governance mechanisms such as voluntary disclosure in shaping tax planning. Using a sample of 3448 firm-year observations of French listed firms over 2007–2013, the results show that voluntary disclosure is associated with lower tax avoidance activities, providing evidence that this disclosure can be seen as an effective monitoring tool that reduces the insiders’ likelihood to engage in rent extraction through tax avoidance activities. The results also indicate that the negative effect of voluntary disclosure on tax avoidance is significant only when family control is below 40%, suggesting that the disciplinary role of voluntary disclosure is limited to firms with relatively low family control levels. Overall, our findings are consistent with the agency theory of tax avoidance and highlight the important role of corporate disclosure in improving corporate governance.

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Notes

  1. The agency view of corporate tax avoidance provides a primary channel through which voluntary disclosure can affect tax avoidance. Despite the existence of an alternative value creation view for tax avoidance, the literature underscores that its potential benefits are typically offset by the increased opportunities for managers to pursue self-serving actions through tax planning, particularly in poorly-governed firms. In this respect, Desai and Dharmapala (2009, pp. 537 and 538) argue that: “the simple view of corporate tax avoidance as a transfer of resources from the state to shareholders is incomplete given the agency problems characterizing shareholder-manager relations” and that “corporate tax avoidance not only entails distinct costs, but these costs may outweigh the benefits to shareholders, given the opportunities for a diversion that these vehicles provide”.

  2. The complexity of tax avoidance stems from the fact that such activity involves the subdivision of the firm into many different business activities (e.g., income qualifying for treaty-based withholding taxes and activity qualifying for the domestic manufacturers’ deduction), a variety of tax-documents (e.g., transfer pricing documentation, signed intercompany agreements; and exemption certificates), and, sometimes, the simultaneous use of local and foreign tax jurisdictions (i.e., tax-motivated transfer pricing and cost-sharing agreements). Balakrishnan et al. (2019) provide other examples of tax planning strategies that increase corporate opacity such as the creation of entities for multi-state tax planning (e.g., captive real estate investment trusts [REITs] and intangible holding companies), net operating loss monetization, and capital loss utilization.

  3. Kovermann and Velte (2019) provide a succinct overview of this literature that largely underscores the importance of agency costs associated with tax avoidance activities.

  4. In France, the 2014 Finance Bill introduced a new anti-hybrid financing measure limiting the deductibility of interests accrued to related party lenders, which represents France’s first concrete step to give effect to the BEPS project (Deloitte & tax@hand 2014).

  5. Art. 223 B quinquies of the French Tax Code.

  6. In many other studies, tax avoidance is measured using the current effective tax rate (current tax expense to pretax income ratio). In our main analysis, we opt for cash effective tax rates rather than current effective tax rates to encounter some limitations. Indeed, tax expense includes current tax expense and deferred tax expense which means that if a firm accelerates deductions and deferring income for tax purposes, this diminishes current taxes but increases deferred taxes. This will not be captured in the current effective tax rate as it includes both current tax expense and deferred tax expense. Moreover, tax expenses can be overstated compared to taxes paid when firms have stock option deductions because when employees exercise their stock option rights, which is not considered in tax expenses (Dyreng et al., 2010).

  7. Our results remain qualitatively the same when we use fixed effects estimations (Table 6, Columns 1–3).

  8. A finding of greater tax aggressiveness in family firms is consistent with family owners valuing the tax savings and rent extraction more than the associated costs: price discount, IRS penalty, and reputation damage.

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Authors and Affiliations

  1. EM Normandie Business School, Métis Lab, Paris, France

    Sabri Boubaker

  2. International School, Vietnam National University, Hanoi, Vietnam

    Sabri Boubaker

  3. Department of Economics and Management (DEM), Faculté de Droit, d’Économie et de Finance (FDEF), University of Luxembourg , Luxembourg City, Luxembourg

    Imen Derouiche

  4. Vietnam National University, Hanoi, Vietnam

    Hung Nguyen

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  1. Sabri Boubaker
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Appendix

Appendix

See Table 8.

Table 8 Voluntary disclosure checklist
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Boubaker, S., Derouiche, I. & Nguyen, H. Voluntary disclosure, tax avoidance and family firms. J Manag Gov 26, 129–158 (2022). https://doi.org/10.1007/s10997-021-09601-w

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