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Family firms, tax avoidance, and socioemotional wealth: evidence from tax reform in Taiwan

Abstract

In 2018, Taiwan implemented a tax reform package that abolished the imputation regime, providing managers stronger incentive to engage in tax avoidance. This paper employs this unique setting to examine how the Taiwan’s 2018 tax reform affects the relation between family firms and tax avoidance based on a socioemotional wealth (SEW) view. I find that family firms on average exhibit lower tax aggressiveness than nonfamily firms. Further, I discover that family firms are disinclined to engage in tax avoidance to a greater extent after the policy change. Moreover, I determine that the negative association between family firms and tax avoidance is more salient for firms with strong control-enhancing mechanisms. Further, additional analyses indicate that family firms may also perceive tax avoidance to be potentially risky and value-destructive and thus are disinclined to engage in it. Collectively, my evidence is consistent with the predictions under the SEW view.

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Notes

  1. Chen et al. (2010) classified roughly 48% of sample firms as family firms. This paper defines family firms by imposing stricter conditions. For detailed classification conditions, please refer to Sect. 3. Given these additional conditions, approximately 62% of sample firms in this study are considered to be family firms. Clearly, the different ownership structures of firms in the US and those in Taiwan cause this gap in the classification of family firms.

  2. For example, Micelotta and Raynard (2011), Westhead et al. (2001), Berrone et al. (2010), Craig and Dibrell (2006), and Dyer and Whetten (2006).

  3. The statistics presented in Table 1 illustrate that family firms account for 62% of all listed firms in Taiwan, and the untabulated statistics reveal that family firms account for roughly 50% of total market capitalization in Taiwan during the sample period. These figures are close to those reported by the PricewaterhouseCoopers (2020) survey.

  4. This study focuses mainly on corporate income tax, but businesses also pay substantial amounts in other taxes and may also have incentives to avoid the other taxes. For example, Yeh and Liao (2019) examine the effect of a policy change that reduced estate taxes on the shareholding structure of family-controlled firms in Taiwan; they discover a reduction in the motivation of controlling families to circumvent estate tax by altering the firm shareholding structure following the legal change.

  5. However, Gallemore et al. (2014), who examine the reputational costs of tax avoidance by testing the reputational effects on manager employment and turnover, discover no significant effects during the three years following revelations of tax avoidance. Additionally, they discover no differential changes in sales and sales growth and no impact on the media-derived public reputation of firms that are revealed to be engaged in tax avoidance. Finally, they also reveal that firms that are identified as tax shelter users may not suffer significant reputational costs even in the eyes of tax authorities. In summary, the empirical evidence from Gallemore et al. (2014) contradicts the arguments in favor of a reputation effect.

  6. The SEW framework has been applied in different strategic decision areas, and numerous follow-up papers have used SEW to examine issues related to family firms—for example, R&D investment (Chrisman and Patel 2012), debt financing (Baixauli-Soler et al. 2021), environmental performance (Barrone et al. 2010; García-Sánchez et al. 2021), diversification (Gomez-Mejia et al. 2010), internationalization (Tomo et al. 2021), Covid19 pandemic implications (Gomez-Mejia and Firfiray 2021), and big data (Arzubiaga et al. 2021).

  7. Recent studies suggest that family firms engage in decisions for reasons that are not solely based on financial perspective. For example, family firms typically build long-term, trusting relations with their customers (Craig et al. 2008), invest in pollution control (Berrone et al. 2010), and generally act in socially responsible manner to protect their reputation or enhance the family's image (Dyer and Whetten 2006). These findings are generally consistent with the SEW view.

  8. The information needed to calculate Taiwan firms’ ETRs can be obtained from their financial statements. Furthermore, information on ETRs per se is available in Taiwan firms’ corporate social responsibility reports, the publication of which has been mandatory since 2014. Thus, tax avoidance information is publicly available for my sample period. Therefore, the inferences discussed previously can also be applied to Taiwan’s setting. Moreover, the publication of the names of major tax evaders by government agencies can also reinforce the publicity related to tax avoidance. In Taiwan, the Ministry of Finance has published a list of major tax evaders since 2010, including company names and addresses, names of the major owners of the firms, and dollar amounts of taxes owed, as a means of pressuring the firms to pay these taxes. The list is published annually on July 1, and the number of major tax evasion cases in 2018 reached 921 individuals and companies (Hsu 2019). Thus, media coverage and the publication of information on major tax evaders by Taiwan’s tax agency are likely to result in increased concern among managers regarding the negative effect of tax avoidance information on family firms’ image or reputation.

  9. On average, the cash flow rights of family owners account for only 75% of their control rights (Claessens et al. 2000). The family owners typically have strong executive power in managerial decisions because they tend to hold the top executive positions (Claessens et al. 2002; Fan and Wong 2002).

  10. The statutory corporate income tax rates in Taiwan during 2016–2017 and 2018–2019 are 17% and 20%, respectively.

  11. ETR_cash reflects aggressive tax planning through both permanent and temporary book-tax differences and thus can help capture a firm’s income-shifting behavior over the short run (Hanlon and Heitzman 2010).

  12. The critical control ownership data are collected from Taiwan Economic Journal (TEJ) and are measured using the methodologies suggested by Cubbin and Leech (1983). In addition, family control is the sum of the following direct and indirect ownership measures: the shares directly owned by family members, the cross-holding of listed firms in the same group of companies, the indirect ownership through pyramid structures, and the ownership of the nominal agents of the controlling family.

  13. Only few firms specifically disclose the information of operating loss carryforwards in their financial statements. To avoid s substantial number of missing observations caused by the lack of available loss carryforward data, I use deferred tax assets instead; it is reasonable because loss carryforwards can increase deferred tax assets.

  14. Chen et al. (2010) find that family firms’ average effective tax rate is 0.5 percentage point higher than that of nonfamily firms. My estimate is more than two times theirs; this gap could be attributable to the effect of the 2018 tax reform.

  15. To check for severe multicollinearity, I use Stata 16 to calculate the variance inflation factors (VIFs) for each independent variable exhibited in Tables 5 and 6. The results reveal that no VIFs is greater than 10, indicating no evidence of serious multicollinearity in my models.

  16. In my empirical setting, a valid instrument should be correlated with Family but uncorrelated with tax avoidance. The untabulated results show that Excess is significantly related to Family in the first-stage regressions but is not significantly associated with tax avoidance if I include it in the second-stage regressions. Additionally, as a robustness check, I rerun all the tests using the excess of control rights over a firms’ critical control ownership, and the results are qualitatively the same.

  17. Further, because my Family variable is a time-constant variable, it cannot be included by itself in a fixed-effects model. Instead, I use the correlated random effect approach, which provides a way to include time-invariant variables in what is effectively a fixed-effects analysis (Wooldridge 2016, p. 446).

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Acknowledgements

I greatly appreciate very helpful suggestions and comments from two anonymous reviewers and Editor-in-Chief. In addition, I greatly acknowledge financial support from the Ministry of Science and Technology of Taiwan, R.O.C. (MOST 107-2410-H-011-001-).

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Appendices

Appendix 1: Test of tax avoidance before and after the 2018 tax reform

To test how the 2018 tax reform in Taiwan affects tax avoidance activities, I estimate Eq. (5) as follows:

$$TA_{{{\text{it}}}} = \beta_{0} + \, \beta_{{1}} Post_{{{\text{it}}}} + \, \beta_{{{2}\sim {\text{k}}}} X_{{{\text{it}}}} + YearDummies + IndustryDummies + \, \varepsilon_{{{\text{it}}}}$$
(5)

Post is a dummy, equal to 1 if year is 2018 or 2019 and 0 otherwise. X represent a set of time-variant firm-year control variables, which are the same as the controls in Eq. (1) and defined in “Appendix 2”. Results from model (5) using ordinary least squares (OLS) regressions with standard errors adjusted for heteroskedasticity and within firm clustering are presented in Table 12.

Table 12 Results from regressions of tax avoidance on a dummy variable, post, and other controls

Column (1) of Table 12 illustrates that coefficient on Post is 0.009 (t = 4.29). Further, I rerun the test using TA_gaap instead of TA_cash as the dependent variable. Column (2) reveals that the coefficient on Post is 0.008 (t = 4.21). Both are significant at the 1% level. These results suggest that tax avoidance increases after the elimination of imputation system before controlling for factors affecting tax avoidance activities.

Further, after controlling for all other factors, I find that the coefficient on Post is 0.012 (t = 4.44), which is significant at the 1% level and suggests that tax avoidance significantly increases after the 2018 tax reform. Finally, I rerun the test using TA_gaap instead of TA_cash and report the results in column (4). The coefficient on Post is 0.008 (t = 4.21). The finding again indicates that tax avoidance activities become significantly more active after the 2018 tax reform.

Taken together, these results are consistent with McClure et al. (2018) and Amiram et al. (2019) and support the position that the elimination of imputation provides managers with stronger incentive to engage in tax avoidance.

Appendix 2

See Table 13.

Table 13 Definitions of key and control variables

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Kuo, CS. Family firms, tax avoidance, and socioemotional wealth: evidence from tax reform in Taiwan. Rev Quant Finan Acc 58, 1535–1572 (2022). https://doi.org/10.1007/s11156-021-01029-5

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Keywords

  • Corporate tax avoidance
  • Imputation system
  • Socioemotional wealth (SEW)

JEL Classification

  • G32
  • H26
  • K34
  • M41