The Relation between Corporate Tax Aggressiveness and Future Financial Performance
Asian Tax Journal Vol. 18 No. 3 (2017), pp. 145-182
Abstract
This study examines whether corporate tax aggressiveness affects the future financial performance. Prior research examining the effect of tax avoidance on firm value proxied by Tobin’s Q documents mixed results. For example, Koh et al. (2007), Ki and Lee (2015), and Yoon et al. (2015) show a positive relation between firm value and tax avoidance. In contrast, Son et al. (2012), Ki (2012), and Kang and Ko (2014) show a negative relation between firm value and tax avoidance. Further, Desai and Dhamapala (2009) and Jun (2011) find no relation between firm value and tax avoidance on average. Unlike that, our study is distinct from prior research in that we investigate whether corporate tax aggressiveness are positively or negatively associated with future performance (e.g., return on assets). In general, corporate tax aggressiveness may increase firm value by reducing effective tax rate, as well as increasing net cash flows and net income. With such a broad view, consistent with the origins view of tax avoidance research and with the origins view that tax avoidance is generally a value creating activity. On the other hand, corporate tax aggressiveness may increase agency problem because managers can use firm resources with tax－avoidance activities to exploit their personal benefits and also tax－avoidance activities are difficult to monitor from outside shareholders (Slemrod 2004). Like this, according to the agency view of tax avoidance, conflicts between firms’ owners and its management may arise because managers who are generally expected to make tax－effective decisions may in fact behave opportunistically and divert corporate wealth for their personal benefit (Desai and Dharmapala 2006). Desai and Dharmapala(2006) suggest an agency view on tax avoidance, stating that agency costs in form of managerial rent extraction may result from a complimentary relationship between tax avoidance and managerial diversion. Self－interested managers might use tax avoidance strategies to mask the opportunistic extraction of rents. As well, finance and accounting research increasingly asserts that managers use corporate tax avoidance strategies as a means to reduce corporate financial transparency, thereby affording the managers greater opportunities to conceal rent extraction activities from shareholders. Further, prior study argues that aggressive tax planning can reduce financial reporting transparency, increase investor uncertainty about future profitability, and increase information asymmetry between investors (Kim et al. 2011；Balakrishnan et al. 2012；Donohoe and Knechel 2014 etc.). Then, this paper investigates the extent to which firms with tax aggressive are affected by any such rent extraction or value creating activity, by so doing we presents the results of the empirical examine whether the positive or negative relation between corporate tax aggressiveness and future financial performance. To investigate research question, this paper use the GAAP effective tax rate (GAAP ETR) and cash effective tax rate (CASH ETR) proposed by Dyreng (2008) as a measure of long－run corporate tax avoidance (e.g., five－year cumulative GAAP ETR or CASH ETR). Then, following Donohoe and Knechel (2014) and Park and Chee (2016), we classify firms as tax aggressiveness if they are in the lowest quintile GAAP ETR or CASH ETR respectively. And following Lee (2010), we also define future financial performance as both one－ and two－year ahead return on assets (ROA) as well as Industry－adjusted ROA. This paper include controls for ROA, firm size, leverage, and sales growth and such these variables are correlated with future profitability. And taxes can vary by industry and year, we also include industry and year fixed effects in our analysis. The final sample consists of 6,960 firm－years from KOSPI and KOSDAQ listed firms and non－financial firms with fiscal month of December between 2004 and 2013. The empirical findings of this paper are following. First, after controlling for several factors that affect future profitability, we finds that tax－aggressive firms for tax avoidance affects a negative effect on the future financial performance (e.g., industry－adjusted ROA or ROA) in the next and two subsequent years. This is, firms with tax aggressiveness are related negatively to their future performance. Second, we also find that, relative to firms with low ETRs for five－year ETRs have lower levels of the future financial performance (industry－adjusted ROA or ROA) in the next and two subsequent years. Our results are robust to two alternative measures of tax aggressiveness, including separate continuous ETR*(－1) and indicators based on low quintile of ETRs. Finally, we find that earnings are less persistent for firms with the higher level of tax－aggressive than for firms with the lower level of tax－aggressive firms. This results suggests that firms with tax aggressive deteriorates earnings persistence. Overall, this results implies firms with tax aggressive is likely to be from managerial opportunistic behavior or rent extraction frequently discussed in the prior literature (Slemrod 2004 ；Desai and Dharmapala 2006；Balakrishnan et al. 2012 etc.). In general, these findings are inconsistent with a origins view of tax avoidance as a value enhancing activity. Rather, these results are consistent with a agency view of tax avoidance. Then, the results of this study exhibit inconsistent with the results in Blaylock (2016) find that there is generally positive relation between tax avoidance and future financial performance in a U.S. setting. The contribution we make in our study is to provide empirical evidence on the extent of the relation between corporate tax aggressiveness and future financial performance, to empirically document the negative relation between corporate tax aggressiveness and future financial performance. This paper is the first to examine the effect of tax aggressiveness on firm’s future financial performance in a Korea setting and adds to the related research investigating the consequences of tax aggressiveness. While prior research primarily investigates the relation between firm value and tax avoidance, their results are mixed. Therefore, the findings of this study can shed a further light to potential investors who make investment decision on taxaggressive firms as well as regulatory bodies by providing useful insight on the aggressive tax avoidance activities of a firms, which seems to result in the negative relation between corporate tax aggressiveness and future financial performance. In addition, this study makes an important contribution to the tax avoidance research, and also academics can apply the discussion in this paper to related future researches.
Keywords
- Corporate tax aggressiveness
- Tax avoidance
- Future financial performance
- Industryadjusted ROA
- Earnings persistence
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