Abstract

This study investigates the effect of ownership wedge on effective tax rates(hereafter ETR). The research hypothesis predicts a negative relation between ownership wedge and ETR. The hypothesis is based on the expropriation theory by large investors reported in past literature on corporate governance. The expropriation theory suggests that large investors have incentives to pursue opportunistic private benefits and run counter to minority shareholders’ interests and corporate value. The forms of expropriation includes empire building, income shifting and non－value－maximizing behavior. Among the expropriation activities, the income shifting occurs through related party transactions. The ownership wedge provides incentives for related party transactions. And the related party transactions would result in income shifting. Thus, we expect the ownership wedge to be negatively related with ETR. The empirical proxy for ETR is measured in three different ways according to past literature. The sample consists of firms listed in Fair Trade Commission’s database on ownership wedge for the period 2000－2007. After controlling for variables related with ETR as reported in previous studies, the regression coefficient for ownership wedge shows statistically significant negative sign. The empirical result is consistent with the prediction of the research hypothesis. The findings of this study suggest that measure of ETR is decreasing in ownership wedge. Specifically, the ownership wedge causes income shifting through related party transactions. The income shifting in turn leads to lower ETR. The results may help policy makers better understand how ownership wedge affect firms’ ETR.

Keywords

• ownership wedge
• effective tax rates
• expropriation theory
• income shifting

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