Despite the agency perspective of corporate tax avoidance, there is little empirical evidence that managers do extract rents derived from aggressive tax practices. This study investigates the association between tax aggressiveness and managerial rent extraction by focusing on informed insider trading, a self-serving action with an unambiguous impact on insiders’ personal wealth and representing the most direct channel through which managers expropriate outside shareholders. We find that insiders at firms more aggressive in tax avoidance gain significantly higher returns from insider purchases than insiders in less aggressive firms and this outperformance results from trading on future earnings news. We also find that insiders under the cover of aggressive tax practices more likely trade on bad news through insider sales and gain more from these trades. The overall evidence is consistent with aggressive tax planning serving managerial interests through gainfully exploiting private information and extracting rents from uninformed shareholders.
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See Securities and Exchange Acts of 1933 and 1934, Insider Trading Sanctions Act of 1984, and Insider Trading and Securities Fraud Enforcement Act of 1988.
Section 16(a) of the Securities and Exchange Act of 1934 requires insiders’ trades to be publicly disclosed via the filing of Form 4 to the SEC. Insiders include officers and directors of the issuer as well as beneficial owners of more than 10% of any equity class of securities of an issuing company.
We follow prior research and compute abnormal trading returns over the event window of (1, 180) because the “short-swing” rule of Section 16(b) of the 1934 Act imposes penalty on profits earned on trades made fewer than 180 days subsequent to prior trades.
Lisowsky (2010) extends Wilson’s (2009) model by including more predictors. One of the key inputs in the expanded model is tax haven information for firm subsidiaries. Due to lack of readily available information on this input, we are unable to use this expanded model. However, Lisowsky (2010) also estimates the coefficients on Wilson’s (2009) predictors.
In 1993, FAS 109, Accounting for Income Taxes, was enacted and the statutory corporate income tax rate increased from 34 to 35%. To ensure that regulatory events regarding income taxes around 1993 do not affect our results, we replicate our analyses using the sample from 1995 to 2017 and obtain similar results.
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See Table 9.
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Jia, Y., Gao, X. Is managerial rent extraction associated with tax aggressiveness? Evidence from informed insider trading. Rev Quant Finan Acc 56, 423–452 (2021). https://doi.org/10.1007/s11156-020-00898-6
- Tax avoidance
- Insider trading
- Rent extraction