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Languages and corporate tax avoidance

Review of Accounting Studies volume 27, pages 148–184 (2022)Cite this article

Abstract

This paper examines the effect of languages on corporate tax avoidance. We hypothesize and find that managers of firms in countries with languages that grammatically distinguish the future from the present (languages with a strong future time reference or FTR) perceive the potential future tax repayments and penalties to be more distant and therefore engage in more tax avoidance. Further tests exploiting the variation in language FTR within Switzerland and Belgium, which have different official languages in different regions but a single tax system, suggest that our findings are not driven by country-level differences in the tax system. We also provide evidence that U.S. firms with CEOs born in countries with strong FTR languages avoid more taxes than those with CEOs born in weak FTR countries, indicating that it is the CEO’s native tongue that affects tax avoidance. Collectively, our findings highlight the importance of social norms in understanding corporate tax strategies.

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Fig. 1

Notes

  1. In our model, we assume that corporate managers do not have biases regarding the timing of future rewards and thus language FTR does not affect tax avoidance through the belief channel discussed in the model of Chen (2013). This is one limitation of our model.

  2. Future-time reference was a focal area of the EUROTYP Theme Group on Tense and Aspect, which studied the typological and areal distribution of grammaticalized future-time reference. The resulting working group summarized their findings in an 846-page volume on Tense and Aspect, edited by Osten Dahl (2000). We follow Chen (2013) and adopt a future-time criterion from typological linguistics to separate languages into weak and strong FTR.

  3. Our sample spans from 2003 to 2017 because statutory tax rates in different countries are available in this period from the KPMG Global Tax Rate Survey.

  4. Firms in South Africa are excluded from the sample because the culture control variables are available only for white people, and there are at least 35 languages spoken in South Africa of which 10 are official languages.

  5. Data of Hofstede (2001) are based on surveys of IBM employees in over 70 countries designed to understand differences in corporate culture. Hofstede uses factor analysis to identify four dimensions of cultural variation: individualism, power distance, masculinity, and uncertainty avoidance. The Economic Freedom Index is from a survey published by the Fraser Institute (www.fraserinstitute.org).

  6. Bertrand et al. (2004) show that clustered standard errors have a downward-biased component when the number of clusters is less than 50 and that this downward bias asymptotically disappears when the number of groups is larger than 50. Because our sample contains observations from 36 countries, we expect our results to be less subject to the downward bias concern documented by Bertrand et al. (2004) when the standard errors are clustered at the firm level.

  7. We show in Table 4 that the relation between TaxAvoidance and ROA is positive when we control for the cross-country variation in the number of observations using the country-industry-year regression.

  8. The Compustat Global database reports firms’ current headquarters. Thus it is likely that some firms in our sample changed the headquarters location during the sample period, and the location changes are associated with changes in the official language. To mitigate this concern, we manually checked the headquarters locations of each firm in our Swiss sample and Belgian sample in Google and Wikipedia. If firms do not change the headquarters locations during the sample period, we keep the location as reported by the Compustat Global database. If firms changed the headquarters location during the sample period, we replaced the headquarters location before the change reported by the Compustat Global database with the one that we collected from Google and Wikipedia.

  9. We use cash effective tax rate (Cash ETR) and GAAP effective tax rate (GAAP ETR) to compare tax avoidance for firms in the same country. The results for Swiss firms also hold if we use TaxAvoidance to measure tax avoidance (untabulated).

  10. As the sample size is relatively small, our tests do not have enough power to detect significant relations between tax avoidance and firm characteristics other than ROA.

  11. To save space, we report the coefficients on control variables in Table OA1 of the online appendix.

  12. To save space, we report the coefficients on control variables in Table OA2 of the online appendix.

  13. To save space, we report the coefficients on control variables in Table OA3 of the online appendix.

  14. Debt and equity financing could be also used as tax avoidance strategies, e.g., stock options and deferred compensation that generate tax savings, and debt as tax shield. Therefore theoretical relations between tax avoidance and changes in debt and equity are ambiguous.

  15. We use changes in debt and equity positions, because individual components of debt and equity financing, such as debt issuances, debt repayment, equity issuances, and share repurchases are missing for a substantial proportion (50% to 80%) for the observations in our main sample.

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Acknowledgements

We are grateful to Jennifer Blouin (the editor) and an anonymous referee for many insightful comments and suggestions that helped us significantly improve the paper. We also thank Vedran Capkun, Mary Ellen Carter, Michael Dambra, Mark Defond, Luzi Hail, Shane Heitzman, Kai Wai Hui, Alan Jagolinzer, Kelvin Law, Jing Li, Mark Ma, Shiheng Wang (discussant), Xin Wang, Franco Wong, Joanna Wu, Eric Yeung, Jerry Zimmerman and seminar participants at Huazhong University of Science and Technology, The University of Hong Kong, and the 2018 MIT Asia Conference in Accounting for helpful comments and suggestions

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Authors and Affiliations

  1. Cheung Kong Graduate School of Business, Beijing, China

    Ke Na

  2. Department of Accounting, Nanjing University, Nanjing, China

    Wenjia Yan

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Na, K., Yan, W. Languages and corporate tax avoidance. Rev Account Stud 27, 148–184 (2022). https://doi.org/10.1007/s11142-021-09596-7

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Keywords

  • Social norms
  • Languages
  • Corporate tax avoidance

JEL

  • H26
  • M41
  • Z10