Is Corporate Social Responsibility Perfo 2

J Bus Ethics (2015) 127:439–457 DOI 10.1007/s10551-014-2052-8

Is Corporate Social Responsibility Performance Associated with Tax Avoidance? Roman Lanis • Grant Richardson

Received: 6 July 2013 / Accepted: 6 January 2014 / Published online: 18 January 2014  Springer Science+Business Media Dordrecht 2014

Abstract This study examines whether corporate social responsibility performance is associated with corporate tax avoidance. Employing a matched sample of 434 firm-year observations (i.e., 217 tax-avoidant and 217 non-taxavoidant firm-year observations) from the Kinder, Lydenberg, and Domini database over the period 2003–2009, our logit regression results show that the higher the level of CSR performance of a firm, the lower the likelihood of tax avoidance. Our results indicate that more socially responsible firms are likely to display less tax avoidance. Finally, the results from our additional analysis show that the CSR categories community relations and diversity represent particularly important elements of CSR performance that reduce tax avoidance. Keywords avoidance

corporate tax policy is generally deemed separate to a firm’s CSR policy, nevertheless, tax avoidance has significantly impacted the social agenda worldwide, especially in this post global financial crisis environment (CTJ 2011; Peters 2011; Duhigg and Kocieniewski 2012). Many would consider tax avoidance to be socially irresponsible (Landolf 2006; Williams 2007; Avi-Yonah 2008; Hasseldine and Morris 2013). Thus, we expect socially responsible firms to be less tax avoidant because we view a firm as a ‘‘real world’’ entity in which CSR is a legitimate business activity and not merely a cost on the road to maximizing shareholder wealth (Avi-Yonah 2008). Our expectation is also consistent with Porter’s view (Porter and Kramer 2006, p. 84) as follows: …The mutual dependence of corporations and society implies that both business decisions and social policies must follow the principle of shared value. That is, choices must benefit both sides. If either business or a society pursues policies that benefit its interests at the expense of the other, it will find itself on a dangerous path. A temporary gain to one will undermine the long term prosperity of both.

Society  Corporate social responsibility  Tax

Introduction A research topic rarely investigated in the business literature is whether corporate social responsibility performance of a firm influences its level of tax avoidance.1 While

R. Lanis (&) Accounting Discipline Group, UTS School of Business, University of Technology, Sydney, Corner of Quay Street and Ultimo Road, Haymarket, Sydney, NSW 2000, Australia e-mail: [email protected] G. Richardson Discipline of Accounting and Information System, The Business School, University of Adelaide, 10 Pulteney Street, Adelaide, SA 5005, Australia e-mail: [email protected]

The non-agency theory based accounting literature has broadly examined the association between CSR performance and disclosure (e.g., Roberts 1992; Gray et al. 1995; 1

In line with existing empirical business research (e.g., Rego 2003; Frank et al. 2009; Chen et al. 2010), we define corporate tax avoidance as the downward management of taxable income through tax-planning activities. We specifically define a tax avoidant firm as one that has had a tax dispute involving federal, state, local or nonU.S. government authorities, or was involved in a controversy over its tax obligations which raised public concern during the period (MSCI 2012). Hence, tax avoidance may include tax-planning activities that are legal or that may fall into the gray area. This differentiates tax avoidance from tax evasion which only relates to illegal activities.

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Neu et al. 1998; Richardson and Welker 2001; Deegan 2002; Deegan et al. 2002; Patten 2002; Al-Tuwaijri et al. 2004; De Villiers and Van Staden 2006, 2010, 2011; Clarkson et al. 2008, 2011), and to a smaller degree the association between CSR and financial performance (e.g., Margolis and Walsh 2001; Scholtens 2008; Callan and Thomas 2009), CSR and earnings management (e.g., Patten and Trompeter 2003; Yip et al. 2011; Kim et al. 2012), and board characteristics and CSR (e.g., O’Neill et al. 1989; Ibrahim and Angelidis 1995; De Villiers et al. 2011; Zhang et al. 2013). In most cases, these studies find that CSR is associated with disclosure, financial performance and earnings management. Our study is one of the first in the area of CSR and tax avoidance, and represents a significant advance and improvement on prior research. We extend a recent Australian study by Lanis and Richardson (2012) about the association between CSR and tax avoidance, and provide further confirmation of an association between tax avoidance and CSR using, for the first time, a direct measure of tax avoidance. More specifically, employing US data, we improve on Lanis and Richardson’s (2012) analysis based on firm annual reports, by utilizing a more objective source of firm CSR performance which is the Kinder, Lydenberg, and Domini (KLD) database.2 Questions have also been raised in prior research about the accuracy of effective tax rates (ETRs) as proxy measures of tax avoidance that were used by Lanis and Richardson (2012) in their study (see, e.g., Frank et al. 2009; Wilson 2009; Lisowsky 2010). Hence, we utilize a direct measure of tax avoidance (from the KLD database) based on tax disputes in our research design to overcome this potential limitation.3 In fact, tax disputes are a likely strong sign of tax avoidance (Graham and Tucker 2006; Lanis and Richardson 2011). 2

The KLD/MSCI STATS database includes over 90 indicators in seven stakeholder or social issue areas, including: community relations, corporate governance, diversity, employee relations, environment, human rights, and issues related to firm’s products and core business. The data set also includes over 20 indicators in the following controversial business issues: alcohol, firearms, gambling, military, nuclear power, and tobacco. All indicators are rated positive, negative or neutral. STATS data is published once at the end of each calendar year. The data is a snapshot of a firm’s social and environmental performance at that moment in time. It includes observations for each year (beginning with 1991) and provides a table of data with a collection of around 650 firms that comprise the FTSE KLD 400 Social Index and S&P 500 with one record for each firm. Beginning in 2001, KLD expanded its coverage to include the largest 1,000 US firms by market capitalization. In 2003, KLD again expanded the coverage to the largest 3,000 US firms by market capitalization (MSCI 2012). 3 As a sensitivity analysis of our main results, we also employ several indirect proxy measures of tax avoidance based on book-tax differences (BTDs) in our study. Prior research finds that BTDs are a more precise measure of tax avoidance compared with ETRs (see, e.g., Frank et al. 2009; Wilson 2009; Lisowsky 2010).

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A prior US study by Huseynov and Klamm (2012) only partially analyzed the impact of CSR performance4 on tax avoidance, employing a narrow sample of firms that use auditor-provided tax services. They also utilized several proxy measures of tax avoidance based on ETRs, which may be problematic as indicated above. These issues cast some doubt on the reliability and generalizability of their results. In an unpublished study Watson (2011) used the whole KLD index as a measure of CSR performance, unrecognized tax benefits as a proxy measure of tax avoidance, and a somewhat broader sample of firms. He finds that socially responsible firms are less tax avoidant. A recent study by Hoi et al. (2013) indicates that firms with excessive irresponsible CSR activities (using only the negative KLD social ratings) have a higher likelihood of engaging in tax sheltering activities. Similar to the other studies in the area, Hoi et al. (2013) use indirect measures of tax avoidance, such as ETRs in their research. Finally, using a different proxy for CSR performance, Davis et al. (2013) find that managers and other stakeholders do not view the payment of corporate taxes as an important feature of a firm’s socially responsible behavior. Given the mixed results to date, we empirically analyze the association between CSR and tax avoidance based on tax disputes, instead of potentially problematic indirect proxy measures of tax avoidance based on ETRs. Hence, the purpose of our study is to examine whether a firm’s CSR performance is related to its level of tax avoidance using a more rigorous research design that potentially furnishes more reliable and generalizable results than prior research. To achieve this purpose, the view of the firm adopted in our study is more inclusive than that suggested by agency theory, whereby a firm is more than simply a nexus of contracts and should consider stakeholders other than shareholders as also being important to its ongoing operations (Ibrahim and Angelidis 1995; Ibrahim et al. 2003). However, there is significant variation among firms as to how such considerations are achieved (Commission of the European Communities (CEC) 2001). This wider view of a firm is referred to by Avi-Yonah (2008) as the ‘‘real entity view,’’ by Scho¨n (2008) as the ‘‘firm as a real world phenomenon,’’ by Freedman (2003) as the ‘‘enlightened shareholder value,’’ and by Porter and Kramer (2006) as ‘‘strategy and society’’ and ‘‘strategic CSR.’’ A common theme of these views applicable to our study is the idea that a firm exists above and beyond management, shareholders, and any specific stakeholder. In fact, a firm has societal obligations, one of which is to pay its fair share of taxes 4

Huseynov and Klamm (2012) used only three (from a possible seven) components (measures) of CSR performance from the KLD database: (1) corporate governance; (2) community; and (3) diversity.

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Neu et al. 1998; Richardson and Welker 2001; Deegan 2002; Deegan et al. 2002; Patten 2002; Al-Tuwaijri et al. 2004; De Villiers and Van Staden 2006, 2010, 2011; Clarkson et al. 2008, 2011), and to a smaller degree the association between CSR and financial performance (e.g., Margolis and Walsh 2001; Scholtens 2008; Callan and Thomas 2009), CSR and earnings management (e.g., Patten and Trompeter 2003; Yip et al. 2011; Kim et al. 2012), and board characteristics and CSR (e.g., O’Neill et al. 1989; Ibrahim and Angelidis 1995; De Villiers et al. 2011; Zhang et al. 2013). In most cases, these studies find that CSR is associated with disclosure, financial performance and earnings management. Our study is one of the first in the area of CSR and tax avoidance, and represents a significant advance and improvement on prior research. We extend a recent Australian study by Lanis and Richardson (2012) about the association between CSR and tax avoidance, and provide further confirmation of an association between tax avoidance and CSR using, for the first time, a direct measure of tax avoidance. More specifically, employing US data, we improve on Lanis and Richardson’s (2012) analysis based on firm annual reports, by utilizing a more objective source of firm CSR performance which is the Kinder, Lydenberg, and Domini (KLD) database.2 Questions have also been raised in prior research about the accuracy of effective tax rates (ETRs) as proxy measures of tax avoidance that were used by Lanis and Richardson (2012) in their study (see, e.g., Frank et al. 2009; Wilson 2009; Lisowsky 2010). Hence, we utilize a direct measure of tax avoidance (from the KLD database) based on tax disputes in our research design to overcome this potential limitation.3 In fact, tax disputes are a likely strong sign of tax avoidance (Graham and Tucker 2006; Lanis and Richardson 2011). 2

The KLD/MSCI STATS database includes over 90 indicators in seven stakeholder or social issue areas, including: community relations, corporate governance, diversity, employee relations, environment, human rights, and issues related to firm’s products and core business. The data set also includes over 20 indicators in the following controversial business issues: alcohol, firearms, gambling, military, nuclear power, and tobacco. All indicators are rated positive, negative or neutral. STATS data is published once at the end of each calendar year. The data is a snapshot of a firm’s social and environmental performance at that moment in time. It includes observations for each year (beginning with 1991) and provides a table of data with a collection of around 650 firms that comprise the FTSE KLD 400 Social Index and S&P 500 with one record for each firm. Beginning in 2001, KLD expanded its coverage to include the largest 1,000 US firms by market capitalization. In 2003, KLD again expanded the coverage to the largest 3,000 US firms by market capitalization (MSCI 2012). 3 As a sensitivity analysis of our main results, we also employ several indirect proxy measures of tax avoidance based on book-tax differences (BTDs) in our study. Prior research finds that BTDs are a more precise measure of tax avoidance compared with ETRs (see, e.g., Frank et al. 2009; Wilson 2009; Lisowsky 2010).

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A prior US study by Huseynov and Klamm (2012) only partially analyzed the impact of CSR performance4 on tax avoidance, employing a narrow sample of firms that use auditor-provided tax services. They also utilized several proxy measures of tax avoidance based on ETRs, which may be problematic as indicated above. These issues cast some doubt on the reliability and generalizability of their results. In an unpublished study Watson (2011) used the whole KLD index as a measure of CSR performance, unrecognized tax benefits as a proxy measure of tax avoidance, and a somewhat broader sample of firms. He finds that socially responsible firms are less tax avoidant. A recent study by Hoi et al. (2013) indicates that firms with excessive irresponsible CSR activities (using only the negative KLD social ratings) have a higher likelihood of engaging in tax sheltering activities. Similar to the other studies in the area, Hoi et al. (2013) use indirect measures of tax avoidance, such as ETRs in their research. Finally, using a different proxy for CSR performance, Davis et al. (2013) find that managers and other stakeholders do not view the payment of corporate taxes as an important feature of a firm’s socially responsible behavior. Given the mixed results to date, we empirically analyze the association between CSR and tax avoidance based on tax disputes, instead of potentially problematic indirect proxy measures of tax avoidance based on ETRs. Hence, the purpose of our study is to examine whether a firm’s CSR performance is related to its level of tax avoidance using a more rigorous research design that potentially furnishes more reliable and generalizable results than prior research. To achieve this purpose, the view of the firm adopted in our study is more inclusive than that suggested by agency theory, whereby a firm is more than simply a nexus of contracts and should consider stakeholders other than shareholders as also being important to its ongoing operations (Ibrahim and Angelidis 1995; Ibrahim et al. 2003). However, there is significant variation among firms as to how such considerations are achieved (Commission of the European Communities (CEC) 2001). This wider view of a firm is referred to by Avi-Yonah (2008) as the ‘‘real entity view,’’ by Scho¨n (2008) as the ‘‘firm as a real world phenomenon,’’ by Freedman (2003) as the ‘‘enlightened shareholder value,’’ and by Porter and Kramer (2006) as ‘‘strategy and society’’ and ‘‘strategic CSR.’’ A common theme of these views applicable to our study is the idea that a firm exists above and beyond management, shareholders, and any specific stakeholder. In fact, a firm has societal obligations, one of which is to pay its fair share of taxes 4

Huseynov and Klamm (2012) used only three (from a possible seven) components (measures) of CSR performance from the KLD database: (1) corporate governance; (2) community; and (3) diversity.

Is CSR Performance Associated with Tax Avoidance?

lawfully collected by the government (Freedman 2003). While minimizing the amount of corporate taxes paid could be deemed to be a legitimate exercise within the spirit of the law to maximize profits, where firms deliberately engage in behavior designed solely to minimize corporate taxes, such behavior has also attracted public concern (Landolf 2006; Williams 2007; Hasseldine and Morris 2013). So we conjecture that firms which perform better in relation to their CSR activities are also less likely to engage in tax avoidance. Based on a matched sample of 434 firm-year observations (i.e., 217 tax-avoidant and 217 non-tax-avoidant firmyear observations) from the KLD database covering the period 2003–2009, our logit regression results show that the higher the level of CSR performance of a firm, the lower the likelihood of tax avoidance. Our results thus indicate that more socially responsible firms are less likely to pursue tax avoidance. Finally, the regression results from our additional analysis indicate that the CSR categories community relations and diversity represent especially important elements of CSR performance that lower tax avoidance. This study contributes to the literature in several ways. First, this study helps to answer a recent call made in the literature by Hanlon and Heitzman (2010, p. 146) for an indepth analysis of the association between CSR constructs and tax avoidance. Second, using a direct measure of tax avoidance based on tax disputes, this study provides empirical evidence which shows that firms with better CSR performance are less likely to engage in tax avoidance. This suggests that CSR represents a core activity that can be used by a firm to support its tax position. Third, this study also provides important insights for policymakers and regulators who seek to identify the circumstances under which the risk of tax avoidance is higher. The remainder of this paper is organized as follows. The next section reviews relevant theory and develops our hypothesis. This is followed by a discussion of the method of sample selection and formation process, and a description of the research design. Next, we report the results. The final section concludes the paper.

Conceptual Framework The Firm: More than Just a Nexus of Contracts Porter and Kramer (2006), Avi-Yonah (2008), and Scho¨n (2008) view the firm as having a major influence that goes beyond its shareholders. Specifically, a firm is a ‘‘real world’’ entity which has to survive the rigors of a competitive business environment, and in this context, will deal with many other entities and individuals (Avi-Yonah

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2008; Scho¨n 2008). Thus, a firm will develop policies, strategies, and operations that will provide it with the most favorable outcomes in a complex business environment. Essentially, the resultant policies, strategies and operations will not be shareholder-centric per se, but will account for other stakeholders (e.g., government bodies, political groups, trade unions, community, employees, suppliers, and customers) and members of society as a whole. Porter and Kramer (2006, p. 83) describe this as follows: To say broadly that business and society need each other might seem like a cliche´, but it is also the basic truth that will pull companies out of the muddle that their corporate-responsibility thinking has created. According to Avi-Yonah (2008), the implication of viewing a firm as a ‘real world’ entity is that CSR may be regarded as a legitimate business activity and not merely a cost on the road to maximizing shareholder wealth. Porter and Kramer (2006) suggest that virtually every activity in a firm’s value chain touches on the communities in which it operates, creating either positive or negative social consequences. They also suggest that any firm which pursues its ends at the expense of society will find its success to be illusory and ultimately temporary. Williams (2007) goes further in suggesting that CSR activities should be reflected in a firm’s strategies and core activities in recognition of its responsibility to society. However, CSR activities are generally not compulsory, i.e. not legislated, in most developed countries (e.g., Australia, Canada, the UK, and the US). In fact, whilst a firm, like an individual, is able to set its own agendas and policies to further its own ends (Williams 2007; Scho¨n 2008), a firm is an integral part of society and requires its support to survive (Roberts 1992; Gray et al. 1995; Deegan 2002). Moreover, the relevance of CSR performance (which is part and parcel of a firm’s core business operations) gains further credibility given a firms’ ethical and moral duty to the wider societal context in which it exists (Freedman 2003; Porter and Kramer 2006; Williams 2007; Scho¨n 2008; Avi-Yonah 2008). However, there is no regulatory regime in place in a country (including the US) to mandate the CSR activities of a firm (Williams 2007; Avi-Yonah 2008).5 Thus, a firm has the choice to formulate a particular strategy to CSR, and in that sense we expect that the level to which firms engage in CSR activities will differ significantly (e.g., CEC 2001; Porter and Kramer 2006; 5

For instance, community and political involvement, environmental protection, social and community development and investment, promoting staff welfare and development, and having policies in place that maintain a good relationship with customers, suppliers and government bodies (Lanis and Richardson 2012).

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Williams 2007; Avi-Yonah 2008; KPMG 2011).6 A relatively recent survey of CSR reporting by KPMG (2011) highlights that such variation is more evident in the US than in Europe and Japan. As indicated by the Government Accountability Office (GAO) (2005), the US has no broad federal CSR mandate. In 2005, it identified 12 US agencies with over 50 programs, policies, and activities that generally fall into four key government roles of endorsing, facilitating, partnering, and mandating corporate CSR activities. However, many of these programs are small in terms of both staffing arrangements and budgets, and try to accomplish broader agency mission goals, rather than being specifically designed to facilitate or promote a firm’s global CSR activities. The U.S. Government endorses CSR by providing awards to firms (e.g., the Department of State’s Award for Corporate Excellence) and discussing CSR in public speeches (GAO 2005). Federal programs facilitate CSR primarily by supplying information or providing funding and incentives to key players who engage in CSR (GAO 2005). Thus, in the absence of any mandatory requirements, firms choose whether and to what extent they take an ethical stance in relation to their business operations; CSR provides a set of guiding principles that can be used to determine how the adopted ethical stance applies to specific business situations that affect stakeholders (other than shareholders) and society in general (Porter and Kramer 2006; Williams 2007). However, the ethical stance could also be significantly different amongst firms. Corporate Taxes and Society Taxes represent a key factor in many corporate decisions. Managerial actions designed exclusively to reduce corporate taxes by way of tax avoidance activities are becoming an increasingly common feature of the corporate landscape all over the world.7 Thus, the issue of firms paying their fair share of corporate tax from a national perspective is, as Andreoni et al. (1998, p. 818) state: ‘‘a problem as old as taxes themselves … and is thus of obvious importance to nations around the world.’’ We take this a step further by suggesting that there is sufficient interest between the state and society for the payment of corporate tax to be considered as a payment to 6 The CEC (2001, p. 4) claims that CSR: ‘‘is essentially a concept whereby companies decide voluntarily to contribute to a better society and a cleaner environment.’’ Hence, there should be wide variation in the CSR performance of firms, which logically leads researchers to ask whether such variation impacts other corporate attributes and policies. 7 See the widely reported cases in the world media of Apple, Google and Starbucks, for example.

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the community generally (Williams 2007). Hence, the payment of corporate taxes can only be associated with CSR if it indeed has implications for the wider community. If the payment of corporate taxes is merely perceived as a business transaction and one of the many costs of operating a firm, the aim would be to minimize, as much as possible, the amount of corporate tax payable (Avi-Yonah 2008). In paying tax a firm would have few ethical, community, or other stakeholder considerations in mind. However, it is asserted by Freedman (2003), Landolf (2006), and Friese et al. (2008), for example, that the payment of corporate taxes does have community and societal implications because it forms the vital function of helping to fund the provision of public goods in society (e.g., education, national defense, public health care, public transport, and law enforcement). Where a firm undertakes tax avoidance activities, this behavior could have a negative effect on society. In this case, the firm is generally deemed not to be paying its ‘‘fair share’’ of corporate income tax to the government to ensure the financing of public goods, therefore producing a significant and potentially irrecoverable loss to society as a whole (Freedman 2003; Slemrod 2004; Landolf 2006; Williams 2007; Erle 2008; Friese et al. 2008; Scho¨n 2008). This shortfall in corporate tax revenue frequently generates hostility, reputational damage for a firm with various stakeholders, and at worst, could even result in the cessation of a firm’s business operations (Williams 2007; Erle 2008; Hartnett 2008). Furthermore, a firm’s decisions about the lengths to which it is prepared to go to reduce its tax liability are legitimately influenced by its attitude to CSR, as well as by considerations of legality and more fundamental ethical questions (Christensen and Murphy 2004; Desai and Dharmapala 2006; Avi-Yonah 2008). Williams (2007) indicates that the most significant conflict which arises in applying CSR principles to corporate tax are those areas where a firm can reduce its tax liability through tax avoidance and tax planning. Tax Avoidance: A Social Irresponsibility Taking the viewpoint that a firm is a ‘‘real world’’ entity with societal obligations, and that the payment of corporate tax positively affects society, the CSR obligation is that a firm should pay its fair share of tax lawfully collected by governments in whichever country it is operating (Freedman 2003; Christensen and Murphy 2004). Thus, a firm may have the right to minimize tax within the spirit of the law, but it would be considered illegitimate to engage deliberately in strategic tax behavior designed solely to minimize its corporate taxes (Avi-Yonah 2008). Moreover, it would

Is CSR Performance Associated with Tax Avoidance?

presumably be socially responsible to take any steps that would curb the harmful effects of tax avoidance on the economic wellbeing of society. According to Williams (2007), eliminating the tax aggressive behavior of a firm should have a stabilizing effect on society to the extent that it: (1) hinders the development of a two-tiered society in which some pay tax and others fail to do so; (2) promotes respect for the rule of law; and (3) contributes to the higher standards of customer service and employee care normally associated with the legitimate economy. By taking a passive stance towards taxation, a firm can gain legitimacy in society and retain good-standing with the tax authority by complying with and following the underlying spirit of the tax law (Christensen and Murphy 2004; Ostas 2004; Rose 2007). In the US, if a transaction is carried-out by a firm that has no valid business purpose other than to avoid tax and a simpler set of transactions could have been undertaken, the Internal Revenue Service (IRS) has the power under the Tax Code (s.482) (US Treasury 2012) to re-characterize the transaction in a way that affects the tax outcome. For example, the IRS can look through a transaction’s legal form to its economic substance and can deny tax benefits or re-characterize transactions in a way that is less favorable to the firm (Scholes et al. 2005). In fact, corporate tax avoidance has not gone unnoticed by the US public, with frequent media reports about the phenomenon arousing significant public concern. For example, there is a great deal of recent public concern about the lack of payment of corporate income taxes by many large multinational US firms such as Amazon, Apple, Bank of America, Boeing, Carnival Cruise Lines, Chevron, Citigroup, ConocoPhillips, Exxon-Mobile, General Electric, Goldman Sachs, Google, Hewlett-Packard, Microsoft, and Valero Energy, to name but a few (Peters 2011; Duhigg and Kocieniewski 2012). Apple was one of the first technology firms in the world to designate overseas salespeople in high-tax countries in such a way that allowed them to sell on behalf of low-tax subsidiaries on other continents, avoiding the payment of corporate taxes. Indeed, Apple was a pioneer of an accounting technique known as the ‘‘Double Irish Dutch Sandwich,’’ which reduces corporate income taxes by routing profits through Irish subsidiaries and the Netherlands and then on to a Caribbean country. At present, this technique is used by many other firms—some of which have directly replicated Apple’s methods (e.g., Google).8 According to Duhigg and

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Kocieniewski (2012), without such tactics, Apple’s federal income tax bill in the US would almost certainly have been $2.4 billion higher in 2011. However as it stands, Apple paid cash income taxes of $3.3 billion around the world on its reported profits of $34.2 billion in 2011, a tax rate of approximately 9.6 percent in 2012. In comparison, WalMart paid worldwide cash taxes of $5.9 billion on its booked profits of $24.4 billion, a tax rate of around 24.2 percent, which is about average for non-tech firms in the US (Duhigg and Kocieniewski 2012). Taking these views into account, tax avoidance should be considered a socially irresponsible and illegitimate activity. Thus, a firm engaging in tax avoidance policies can be considered socially irresponsible; its decisions about the lengths to which it is prepared to go to reduce its tax liability are influenced by its attitude to CSR, in addition to considerations of legality and more basic ethical questions. Williams (2007) argues that while consideration of basic principles, such as honesty and integrity, is likely to focus on the attributes of the proposed tax avoidance arrangements themselves and the kind of behavior required of a firm, CSR considerations will tend by definition to focus more on the wider economic, social, and environmental effects of the arrangements. It should also be noted that it is not always helpful to seek to distinguish between ‘‘good’’ CSR carried-out by a firm for altruistic motives, and ‘‘selfish’’ CSR carried-out by a firm with a view to the favorable effects on its reputation (Williams 2007). Rather, many corporate actions are conducted with dual motives in mind. It is therefore important in what follows to consider how CSR factors may reasonably influence a firm’s approach to tax avoidance without making any attempt to distinguish between: an action that is taken because a firm actually wishes to act in a responsible manner; and an action that is taken because it wishes observers to perceive it in that particular light (Williams 2007). Against that background, a firm with better CSR performance is expected to be more cautious about undertaking tax avoidance activities as this would be inconsistent with and could potentially counteract the positive effects associated with its CSR activities. Overall, it is reasonable to expect that the better a firm performs with regards to its CSR activities, the lower the likelihood that it will be tax avoidant. Hence, the research hypothesis is: H1 All else equal, the higher the level of CSR performance of a firm, the lower the likelihood of corporate tax avoidance.

8

Specifically, Google cut its worldwide income tax bill by approximately $3.1 billion over 3 years using the ‘‘Double Irish Dutch Sandwich’’ technique which moved profits through units in Ireland, the Netherlands and Bermuda. This tax-cutting strategy helped cut the firm’s income-tax rate to around 2.4 percent on the profits it attributed

Footnote 8 continued to its foreign subsidiaries during the 3-year period. However, the statutory corporate income tax rate in the US is 35 percent (Womack and Drucker 2011).

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Data and Variables

Table 1 Matching statistics for the tax-avoidant and non-tax-avoidant firms ($000)

Sample Description

Variable

Our sample comprises 434 firm-year observations from the KLD database covering the period 2003–2009. Of the 434 observations, 217 are defined as tax avoidance observations. That is the firm has been involved in a major tax dispute involving federal, state, local or non-US government authorities, or was involved in a controversy over its tax obligations which raised public concern during the period 2003–2009. We then match each of the 217 taxavoidant observations with a non-tax-avoidant observation to produce a matched sample of 434 firm-year observations over the period 2003–2009 for empirical testing.

Total assets

Total sales

Market value of equity ETR (%)

Tax-avoidant Firm Sample Selection The sample of tax-avoidant firms includes 71 different firms from the KLD database which are indicated as having a tax dispute in any year during the period 2003–2009. In total, the KLD database contains 261 tax disputes for the period 2003–2009. However, we were unable to match 44 tax disputes with firms that had no tax disputes in a particular year. Therefore, as indicated above, we matched 217 tax dispute observations with 217 non-tax dispute observations, producing a matched sample of 434 firm-year observations covering the period 2003–2009.9 Matched Firm Sample Formation To form the matched sample, we examine all non-tax dispute firms in the KLD database. Non-tax-avoidant firms are identified on the basis of their similarity to the taxavoidant firms in terms of: (1) industry classification; (2) firm size; and (3) time (e.g., Kaplan and Reishus 1990; Beasley 1996). In particular, we identify non-tax-avoidant firms in the same four-digit North American Industry Classification Scheme (NAICS) industry as a given taxavoidant firm in the year of the tax dispute. Firms with a tax dispute in any 1 year were eliminated as a possible nontax dispute firm for all other sample years. Among these same-industry firms, we consider matched firms to be those with a market value of common stock that is ±40 percent of the market value of common stock for a corresponding tax-avoidant firm.10 The matching process

Return on assets (%)

Tax-avoidant firms mean (median) [SD]

Non-tax-avoidant firms mean (median) [SD]

36,191

24,757

(19,272)

(12,572)

[49,573] 22,305

[33,201] 14,713

(10,796)

(6,512)

[43,022]

[27,577]

34,241

28,366

(12,206)

(10,343)

[56,940]

[39,152]

27 %

31 %

(26 %)

(30 %)

[13 %]

[11 %]

9%

10 %

(7 %)

(9 %)

[9 %]

[10 %]

Year and number of tax-avoidant disputes detected over the sample period 2003–2009 2003: 21

2006: 36

2009: 45

2004: 3

2007: 39

Total: 217

2005: 28

2008: 45

Note 1: All of the financial statement data were obtained from the WRDS database Note 2: The ETR is measured as income tax expense divided by pretax accounting income; and return on assets is measured as pre-tax income divided by total assets Note 3: Paired t -tests (Wilcoxon matched-pair sign rank test) for means (medians) are carried-out to determine whether tax avoidant and non-tax-avoidant firms differ significantly in terms of total assets, total sales and market value of equity. No statistically significant differences are found between the variables

generates several matches in some instances and few in others. In those cases we selected the matched firm which had the closest market value of common stock to the tax dispute firm. In so doing, we avoid the situation in which our empirical analysis is overshadowed by cases for which our matching process happens to provide several matches (e.g., Graham and Tucker 2006). This process yields a matched sample that is similar in scope to the tax-avoidant firm sample. Table 1 provides the matching statistics for the taxavoidant and non-tax-avoidant firms. All the financial statement data were obtained from the Wharton Research

9

The KLD data are only available up to 2009 (at the time of the research study) and certain research control variables were not available prior to 2003. Hence, the sample period of 2003–2009 was selected. 10 Although our comparison sample’s cut-off point of ±40 percent appears to be large, it is consistent with Kaplan and Reishus (1990). In addition, most of the tax-avoidant firms and non-tax-avoidant firms

123

Footnote 10 continued in the sample are similar within a range of ±40 percent. As the mean market value of common stock of the tax-avoidant firms in our sample is $34.2 million, the related matched firm size may range from $17.1 to $51.3 million. There is no reason to believe that such a range has a significant impact on our results.

Is CSR Performance Associated with Tax Avoidance?

Data Service (WRDS) database. Based on an overall analysis of the matching statistics reported in Table 1, we find that, on average, the tax-avoidant firms have greater total assets, sales, and market value than the non-tax-avoidant firms. However, we also find that, on average, the taxavoidant firms have lower ETRs (i.e., they pay less corporate income tax) than the non-tax-avoidant firms even though they are almost as profitable as the non-tax avoidant firms (based on return on assets). Finally, a comparison of the means (paired t tests) and medians (Wilcoxon matchedpair sign rank test) reveals no statistically significant differences in the total assets, total sales, market value of common stock, ETRs, and return on assets of the taxavoidant firms and the non-tax-avoidant firms.

Research Design Our research design includes a standard logit regression analysis to test our hypothesis. Logit regression is used in our study for two reasons. First, our dependent variable (tax avoidance) is a dummy variable (Hair et al. 2006). Second, our study uses a choice-based sample (where 50 percent of the firms are tax avoidant firms and 50 percent of the firms are non-tax avoidant firms) instead of a random sample from the population. Yet, it is likely that the actual incidence of tax avoidance in the population of publicly listed U.S. firms is lower than 50 percent (Slemrod 2007; Hanlon et al. 2007). Maddala (1991) argues that logit regression analysis is the most appropriate statistical method to use where there is disproportionate sampling from two populations. Specifically, he asserts that the coefficients of the independent variables are not affected by the unequal sampling rates from the two groups. Rather, it is only the constant term that is affected (Maddala 1991). As our objective is not to build a predictive model of tax avoidance, any potential bias in the constant term should have no impact on our empirical analysis, making logit regression analysis appropriate to use. Dependent Variable The dependent variable for our empirical tests is represented by corporate tax avoidance (TA). Measuring tax avoidance in business research has always been problematic because this variable is not directly observable as a result of the private nature of tax returns and other IRS submissions (Hanlon and Heitzman 2010). Therefore, traditionally, business research has employed proxy measures of tax avoidance obtained from the financial statements (see, e.g., Gupta and Newberry 1997; Rego 2003; Adhikari et al. 2006; Desai and

445

Dharmapala 2006; Chen et al. 2010; McGuire et al. 2012). The two most commonly used proxy measures of tax avoidance computed from financial statement data are ETRs and book-tax differences (BTDs) (Hanlon and Heitzman 2010). However, as Hanlon and Heitzman (2010: 139) point out: ‘‘it is well known that there are many problems with computing estimates of taxable income from financial statements because there is a lack of disclosure in financial statements about taxable income and/or the actual cash taxes paid or to be paid on the current year’s earnings.’’ Furthermore, even if tax return data were publicly available, the issues associated with using financial information to proxy for tax avoidance would not necessarily be resolved (Hanlon and Heitzman 2010). An alternative measure of tax avoidance successfully used in recent accounting and economics research by Graham and Tucker (2006) and Lanis and Richardson (2011) is based on firm tax disputes. This variable represents a direct measure of tax avoidance which can overcome some of the problems of using proxy measures of tax avoidance based on ETRs, for example.11 In fact, as claimed in prominent tax avoidance research conducted by Graham and Tucker (2006) and Lanis and Richardson (2011), a firm which is in dispute with a regulatory authority over tax matters is a likely strong sign of tax avoidance. Accordingly, our tax dispute variable is denoted as a dummy variable tax avoidance (TA), coded 1 if the firm has been involved in a major tax dispute involving federal, state, local or non-US government authorities, or was involved in a controversy over its tax obligations which raised public concern during the period 2003–2009, otherwise 0. To enhance the validity of the dependent variable (TA), we use an independent source for tax disputes in our study, the KLD database, which specifically compiles a tax dispute variable. Finally, in order to improve the generalizability of our main results based on the tax dispute measure of tax avoidance, we also carry out a sensitivity analysis of our main results (see below) using several proxy measures of tax avoidance based on BTDs. Independent Variables Our independent variable is denoted by CSR performance (CSRPERF), which is based on CSR data collected from

11

Moreover, Beasley (1996) also used a direct measure of accounting fraud in his research by studying firms that were in dispute with the Securities Exchange Commission (SEC) over restatements of financials.

123

446

the KLD database covering the period 2003–2009. Specifically, KLD provides integer scores of strengths and concerns for approximately 80 indicators within seven major categories as follows: (1) community relations; (2) corporate governance; (3) diversity; (4) employee relations; (5) environment; (6) human rights; and (7) products.12 Consistent with research by Statman and Glushkov (2009) and Watson (2011), we assign a value of ?1 for every strength and a value of -1 for every concern and then sum the strengths and concerns for each category together into an overall firm score: CSRPERF.13 Prior research supports the use of the KLD database over its alternatives due to its objectivity and management focus (Sharfman 1996; Waddock and Graves 1997; Chand 2006; Callan and Thomas 2009). In fact, Sharfman (1996) carried-out research that analyzed the KLD social responsibility measure to evaluate its construct validity. He found that KLD is well-correlated with other measures of CSR, including ten socially responsible mutual fund holdings, and the Fortune magazine measure of corporate reputation (Sharfman 1996). Control Variables To control for other effects on tax avoidance (TA), we include several variables from the literature in our base regression model that relate to: (1) corporate governance;14 and (2) conventional determinants of tax avoidance. The data for the control variables were collected from the WRDS database. Board of director independence (BODI) controls for differences in the extent of membership of independent directors on the board. Fama and Jensen (1983) claimed that the board is the highest internal control mechanism for monitoring the actions of top management. They argued that outside directors have incentives to conduct their monitoring tasks and not to collude with top managers to expropriate shareholder wealth, so the addition of 12 Additional concerns are noted in the KLD database for activity in the following industry sectors: alcohol, firearms, gambling, military, nuclear, and tobacco. 13 Callan and Thomas (2009) provide detailed discussion of the various ways in which KLD data are used in CSR-related research. They recommend a simple summation or averaging method instead of the more arbitrary weighting methods used in some studies. 14 We note that our corporate governance control variables are consistent with those used in other accounting research (e.g., Beasley 1996). They are different to the corporate governance ratings in the KLD index itself, which consists of limited compensation, ownership strength (which refers to ownership of firms in which KLD has cited as having an area of social strength), transparency (which relates to reporting on a wide range of social and environmental issues), political accountability, and other issues (e.g., the culture of the firm). Thus, the KLD index ratings relating to corporate governance are different to our corporate governance control variables.

123

R. Lanis, G. Richardson

independent directors on the board increases its ability to monitor top management effectively. Lanis and Richardson (2011) found that the addition of a higher proportion of independent directors on the board reduces tax avoidance. BODI is measured as the proportion of board members who are independent directors. Management stock ownership of the board of directors (MTOBOD) controls for differences in the extent to which managers serving on the board of directors own ordinary stock in the firm. Encouraging management to hold a large equity interest in a firm gives them greater incentive to increase firm value (Jensen and Meckling 1976). However, managers may also be motivated to inflate the stock price by engaging in fraudulent behavior (Loebbecke et al. 1989). MTOBOD is measured as the total proportion of corporate stock owned by insiders (e.g., managers) who serve on the board. Block held (BLOCKHLD) controls for differences in the extent of the stockholding by blockholders who hold at least 5 percent of shares and are not affiliated with management (Loebbecke et al. 1989). Blockholders may assist in the monitoring of management as they have greater influence and power over the board and management than other shareholders (Shleifer and Vishny 1986; Jensen 1993). BLOCKHLD is measured as the total proportion of ordinary share capital of blockholders who hold at least 5 percent of outstanding shares and are not affiliated with management. Age public (AGEPUB) controls for differences in the length of time that the firm’s stock has traded in public markets (Loebbecke et al. 1989). It is possible that the longer the firm has traded in public markets, the greater risk it runs of financial wrongdoing as management is compelled to meet earnings expectations constantly over the long-term. Research by Lanis and Richardson (2011) found that the longer the firm has traded in public markets, the greater the likelihood of tax avoidance. AGEPUB is measured as the number of years that the firm’s stock has been traded in public markets. CEO tenure (CEOTENURE) controls for the CEO’s ability to affect board composition and board monitoring of financial wrongdoing (Loebbecke et al. 1989). It is likely that CEOs with many years of experience exert more power than less established CEOs (Hermalin and Weisbach 1988). CEOs are also perceived to have an influential voice about board decisions and board appointments, so there is a greater possibility that more experienced CEOs will act in their own self-interest by engaging in fraudulent activities (Mace 1986). CEOTENURE is measured as the number of years that the CEO has served as a director on the board. CEO duality (CEODUAL) controls for cases where the CEO and chairperson’s positions are combined. As the function of the chairperson is to run the board meetings and

Is CSR Performance Associated with Tax Avoidance?

oversee the process of hiring, firing, evaluating, and compensating the CEO, then the CEO cannot carry out the chairperson’s monitoring function separately from his or her personal interests (Jensen 1993). It is thus necessary to separate the chairperson and CEO positions if the board is to be an effective monitoring device. When the positions of CEO and chairperson are combined, the CEO is also able to influence board composition (Jensen 1993). CEODUAL is measured as a dummy variable that takes a value of 1 if the chairperson of the board also holds the managerial position of CEO or managing director, and 0 otherwise. Big-four auditor (BIG4AUDIT) controls for the use of a big-four audit firm. The use of a big-four audit firm may help to reduce the tax-avoidant activities of the firm via enhanced monitoring and through a higher quality audit. Prior research found a positive association between the engagement of a big-four auditor, the perception of audit quality, and the probability of detecting financial statement fraud (e.g., Matsumura and Tucker 1992; Rezaee 2005). Thus, it is expected that clients of big-four audit firms should exhibit less tax avoidance vis-a-vis non-big-four audit firm clients. BIG4AUDIT is measured as a dummy variable, coded 1 if the firm uses a big-four external auditor, and 0 otherwise. As well as the abovementioned corporate governance control variables, we also include several tax avoidance control variables in our base regression model such as: firm size (SIZE), leverage (LEV), capital intensity (CINT), R&D intensity (RDINT), inventory intensity (INVINT), the marketto-book ratio (MKTBK), and return on assets (ROA). Specifically, SIZE (measured as the natural log of total assets) is used to control for size effects. Based on prior research (Zimmerman 1983), we expect to find that larger firms are likely to be more tax avoidant than smaller firms as they enjoy greater economic and political power compared with smaller firms and are able to reduce their tax burdens accordingly. LEV is long-term debt divided by total assets, CINT is net property, plant and equipment divided by total assets, and RDINT is R&D expenditure divided by net sales. Prior research (Gupta and Newberry 1997) found that LEV, CINT, and RDINT are positively associated with tax avoidance: LEV was positively associated with tax avoidance due to tax-deductible interest payments; CINT was positively associated with tax avoidance because of accelerated depreciation charges corresponding to asset lives; and RDINT was positively associated with tax avoidance owing to tax-deductible R&D expenditure. We also include inventory intensity (INVINT) in our study as a control variable. To the extent that INVINT represents a substitute for CINT, inventory-intensive firms should be less tax avoidant than capital intensive firms (Stickney and McGee 1982). INVINT is measured as inventory divided by total assets.

447

A growth variable, MKTBK (the market value of equity divided by the book value of equity) and a profitability variable, ROA (pre-tax income divided by total assets) (Adhikari et al. 2006) are also included as control variables. Due to the conflicting results obtained for these variables in prior research, we make no sign predictions for ROA and MKTBK. Finally, year (YEAR) dummy variables are also included in our study to control for differences in tax avoidance disputes that exist over the 2003–2009 sample years. Base Regression Model To examine the association between CSR performance and tax avoidance, we estimate the following base regression model: TAit ¼ a0 þ b1 CSRPERFit þ b2 BODIit þ b3 MTOBODit þ b4 BLOCKHLDit þ b5 AGEPUBit þ b6 CEOTENUREit þ b7 CEODUALit þ b8 BIG4AUDITit þ b9 SIZEit þ b10 LEVit þ b11 CINTit þ b12 RDINTit þ b13 INVINTit þ b14 MKTBKit þ b15 ROAit þ b1622 YEARit þ eit ; ð1Þ where i is the firms 1–71; t the period 2003–2009; TA a dummy variable, coded as 1 if the firm has been involved in a major tax dispute involving federal, state, local or nonU.S. government authorities, or was involved in a controversy over its tax obligations which raised public concern during the period 2003–2009, otherwise 0; CSRPERF CSR performance rating of the firm; BODI the proportion of board of members who are independent directors; MTOBOD the total proportion of corporate stock owned by insiders (e.g., managers) who serve on the board; BLOCKHLD the total proportion of ordinary share capital of blockholders who hold at least 5 percent of outstanding shares and are not affiliated with management; AGEPUB the number of years that the firm’s shares have been traded on the stock exchange; CEOTENURE the number of years that the CEO has served as a director; CEODUAL a dummy variable, coded 1 if the roles of chairman and chief executive officer are performed by the same person, otherwise 0; BIG4AUDIT a dummy variable, coded 1 if the firm uses a big four external auditor, otherwise 0; SIZE the natural logarithm of total assets; LEV long-term debt divided by total assets; CINT net property, plant and equipment divided by total assets; RDINT R&D expenditure divided by total assets; INVINT inventory divided by total assets; MKTBK the market value of equity divided by the book value of equity; ROA pre-tax income divided by total

123

448

R. Lanis, G. Richardson

Table 2 Descriptive statistics—full sample Variables

N

Mean

TA

434

0.500

CSRPERF

434

0.138

BODI

434

MTOBOD BLOCKHLD

Std. dev.

Minimum

Median

Maximum

0.500

0

0.50

1

4.253

–10

1

16

0.893

0.141

0.091

0.846

1

434

0.055

0.130

0

0.015

0.957

434

0.149

0.153

0

0.116

0.798

AGEPUB

434

57.667

42.507

0

48

205

CEOTENURE

434

6.045

6.231

0

4

40

CEODUAL

434

0.435

0.496

0

0

1

BIG4AUDIT

434

0.983

0.126

0

1

1

SIZE

434

9.616

1.215

6.701

9.638

12.503

LEV CINT

434 434

0.223 0.436

0.145 0.311

0 0.060

0.225 0.342

0.699 0.998

RDINT

434

0.030

0.065

0

0

0.342

INVINT

434

0.058

0.078

0

0.028

0.538

MKTBK

434

3.748

9.199

-12.467

2.336

44.627

ROA

434

0.092

0.094

-0.577

0.079

0.318

Variable definitions: TA a dummy variable, coded as 1 if the firm has been involved in a major tax dispute involving federal, state, local or nonU.S. government authorities, or was involved in a controversy over its tax obligations to the community during the period 2003–2009, otherwise 0; CSRPERF CSR performance rating of the firm; BODI the proportion of board of members who are independent directors; MTOBOD the total proportion of corporate stock owned by insiders (e.g., managers) who serve on the board; BLOCKHLD the total proportion of ordinary share capital of blockholders who hold at least 5 percent of outstanding shares and are not affiliated with management; AGEPUB the number of years that the firm’s shares have been traded on the stock exchange; CEOTENURE the number of years that the CEO has served as a director; CEODUAL a dummy variable, coded 1 if the roles of chairman and chief executive officer are performed by the same person, otherwise 0; BIG4AUDIT a dummy variable, coded 1 if the firm uses a big four external auditor, otherwise 0; SIZE the natural logarithm of total assets; LEV long-term debt divided by total assets; CINT net property, plant and equipment divided by total assets; RDINT R&D expenditure divided by total assets; INVINT inventory divided by total assets; MKTBK the market value of equity divided by the book value of equity; and ROA pre-tax income divided by total assets

assets; YEAR year dummy variable, coded 1 if the year falls within the specific year category, and 0 otherwise; and e the error term.

Results

that there is a significant difference between the two in terms of CSRPERF (p \ 0.05). For the control variables, we also find that there is a significant difference between the tax-avoidant firm and the non-tax-avoidant firm subsamples for MTOBOD (p \ 0.10 or better), AGEPUB (p \ 0.01), SIZE (p \ 0.01), LEV (p \ 0.01), and INVINT (p \ 0.10).

Descriptive Statistics Correlation Results The descriptive statistics of our variables for the full sample are reported in Table 2. The respective means and medians for all of the other variables are also reported in Table 2. An acceptable range of variation is observed for all of the variables presented in Table 2 in addition to a reasonable level of consistency between the means and medians, reflecting normality of distributions. We also present the descriptive statistics and univariate analysis of our variables for the sub-samples in Table 3. A comparison of the means (paired t tests) and medians (Wilcoxon matched-pair sign rank tests) of the tax-avoidant firm and the non-tax-avoidant firm sub-samples shows

123

The Pearson pairwise correlation results are reported in Table 4. The correlations show that TA is significantly negatively associated with CSRPERF (p \ 0.01). This result indicates that the higher the firm’s level of CSRPERF, the lower the likelihood of tax avoidance. For TA, we also find significant correlations (with predicted signs, where appropriate) with BODI (p \ 0.10), MTOBOD (p \ 0.10), AGEPUB (p \ 0.01), SIZE (p \ 0.01), LEV (p \ 0.01), and RDINT (p \ 0.05). Table 4 also reports the correlations between the explanatory variables. It shows that only moderate levels of collinearity exist between the explanatory variables used in

Is CSR Performance Associated with Tax Avoidance?

449

Table 3 Descriptive statistics and univariate analysis—sub-samples Variables

Tax-avoidant firms (TA = 1)

Non-tax-avoidant firms (TA = 0)

N

Mean

SD

Minimum

Median

Maximum

N

Mean

SD

Minimum

Median

Maximum

CSRPERF

217

0.118**

4.677

-10

1**

14

217

0.158

BODI

217

0.882

0.146

0.091

0.900

1

217

0.905

3.780

-9

1

16

0.136

0.290

1

MTOBOD

217

0.043*

0.095

0

0.013***

0.480

217

0.068

0.157

1

0

0.018

0.957

BLOCKHLD

217

0.145

0.156

0

0.107

0.696

217

0.153

0.154

0

0.120

0.798

AGEPUB

217

63.711***

40.999

0

55***

158

217

51.856

42.396

0

33

205

CEOTENURE

217

6.196

6.689

0

5

40

217

5.894

5.743

0

4

33

CEODUAL BIG4AUDIT

217 217

0.452 0.981

0.499 0.135

0 0

0 1

1 1

217 217

0.419 0.986

0.495 0.117

0 0

0 1

1 1

SIZE

217

9.790***

1.203

7.223

9.866***

12.503

217

9.441

1.204

6.701

9.432

11.49

LEV

217

0.254***

0.148

0

0.253***

0.700

217

0.192

0.136

0

0.195

0.640

CINT

217

0.441

0.300

0.080

0.367

1

217

0.431

0.323

0.060

0.287

0.990

RDINT

217

0.032

0.067

0

0

0.340

217

0.029

0.064

0

0

0.320

INVINT

217

0.052*

0.068

0

0.027*

0.330

217

0.064

0.086

0

0.031

0.540

MKTBK

217

3.955

7.647

-12.467

2.696

44.627

217

3.542

10.541

ROA

217

0.087

0.096

-0.410

0.071

0.420

217

0.098

0.092

0.900

2.136

40.700

-0.577

0.086

0.318

Variable definitions: see Table 2 for variable definitions The p values are one-tailed for directional hypotheses and two-tailed otherwise * Significance at the 0.10 level ** Significance at the 0.05 level *** Significance at the 0.001 level

our study.15 The highest correlation coefficient is between SIZE and RDINT of -0.295 (p \ 0.01). Moreover, we also calculate variance inflation factors (VIFs) when estimating our base regression model to test for signs of multi-collinearity among the explanatory variables. Our (unreported) results confirm that no VIFs exceed five for any of our explanatory variables, so multi-collinearity is not problematic in our base regression model.16 Regression Results Our univariate tests show a significantly negative association between CSR performance and tax avoidance. However, univariate tests implicitly assume that other potentially relevant corporate characteristics are fixed, which may not be the case. We thus employ logit regression analysis to test our hypothesis in a multivariate framework. The logit regression results are presented in Table 5. The regression coefficient for CSRPERF is negative and 15

According to Hair et al. (2006), a correlation coefficient for a pair of explanatory variables between ±0.25 and ±0.75 indicates a moderate level of collinearity between the two variables. 16 Hair et al. (2006) suggest that a VIF value above the threshold of ten corresponds to a high level of multi-collinearity amongst the explanatory variables.

statistically significant (p \ 0.05), which provides support for our hypothesis. Thus, the higher the level of CSR performance of a firm, the lower the likelihood of tax avoidance. This result is consistent with our conjecture that a firm that performs better in CSR activities (e.g., community relations, corporate governance, diversity, employee relations, environment, human rights, and products) reduces the likelihood of tax avoidance. In terms of the regression coefficients for the control variables, Table 4 shows that several are statistically significant. BODI controls for differences in the extent of membership of independent directors on the board. We find that BODI has a significantly negative association with TA (p \ 0.05), which shows that the inclusion of a higher proportion of outside members on the board reduces tax avoidance due to improved monitoring of top management (Lanis and Richardson 2011). AGEPUB controls for the number of years the firm’s shares have been publicly traded. It has a significantly positive association with TA (p \ 0.01), which indicates that the longer the firm’s shares have traded in public markets, the greater risk the firm runs of financial wrongdoing and tax avoidance as management is required to meet earnings expectations constantly over the long-term (Loebbecke et al. 1989). SIZE controls for firm size effects. It has a significantly positive association with TA (p \ 0.01), which shows that larger firms are more

123

123

CSRPERF

MTOBOD

BODI

BLOCKHLD

AGEPUB

CEOTENURE

CEODUAL

BIG4AUDIT

SIZE

LEV

CINT

RDINT

INVINT

MKTBK

ROA

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

0.056

0.023

-0.078*

0.084**

0.012

0.214***

0.144***

-0.020

0.033

0.020

0.119***

-0.027

-0.078*

-0.093*

-0.163***

–

0.197***

0.054

0.010**

0.291***

0.112**

-0.198***

-0.030

0.048

-0.036

-0.026

0.134***

0.018

0.084*

-0.001

–

2.

0.010

0.044

0.009

0.143***

-0.009

-0.048

-0.166***

0.028

0.113**

0.238***

-0.110**

-0.031

-0.186***

–

3.

-0.038

-0.036

-0.067

0.063

0.087*

0.077

0.005

0.044

0.065

0.048

0.066

0.051

–

4.

-0.079

0.070

0.035

-0.039

0.039

0.203***

0.251***

0.213***

0.192***

0.022

-0.146***

–

5.

*** Significance at the 0.001 level

** Significance at the 0.05 level

* Significance at the 0.10 level

The p values are one-tailed for directional hypotheses and two-tailed otherwise

N = 434 for all variables

Variable definitions: see Table 2 for variable definitions

TA

1.

1.

Table 4 Pearson pairwise correlation results

0.078

-0.010

0.014

-0.020

-0.017

-0.006

0.010**

0.029

-0.053

-0.143***

–

6.

0.027

0.017

-0.054

0.104**

-0.046

-0.163***

-0.112**

0.005

0.009

–

7.

0.015

0.046

-0.014

0.091*

0.058

0.008

-0.027

0.002

–

8.

0.018

0.026

0.014

0.024

0.083*

-0.195***

0.026

–

9.

-0.142***

-0.118**

-0.295***

-0.009

0.058

-0.105**

–

10.

-0.253***

-0.055

-0.107**

0.269***

0.255***

–

11.

-0.023

0.043

0.078

-0.170***

–

12.

0.162***

0.086*

-0.023

–

13.

0.074

-0.003

–

14.

0.121**

–

15.

-

16.

450 R. Lanis, G. Richardson

Is CSR Performance Associated with Tax Avoidance?

451

Predicted sign

TA

exploit R&D expenditure tax incentives to facilitate tax avoidance (Stickney and McGee 1982).

Intercept

?

7.572 (3.55)***

Additional Analysis

CSRPERF

-

-0.079(-2.24)**

BODI

-

-0.390 (-1.76)**

MTOBOD

?

-0.532 (-1.29)

Table 5 Logit regression results—base CSR model Variables

BLOCKHLD

-

-0.074 (-0.09)

AGEPUB

?

0.008 (2.40)***

CEOTENURE

?

0.013 (0.64)

CEODUAL

?

0.119 (0.37)

BIG4AUDIT

-

-0.150 (-1.22)

SIZE

?

0.322 (2.50)***

LEV CINT

? ?

0.734 (4.75)*** 0.927 (2.19)**

RDINT

?

0.098 (2.90)***

INVINT

-

-0.625 (-0.28)

MKTBK

?

0.002 (0.11)

ROA

?

0.015 (0.01)

YEAR

?

Yes

As mentioned in the discussion of the CSR performance independent variable, KLD provides integer scores of strengths and concerns for approximately 80 indicators within seven major categories, including: (1) community relations; (2) corporate governance; (3) diversity; (4) employee relations; (5) environment; (6) human rights; and (7) products. We are particularly interested in carrying out an additional logit regression analysis to determine which of the seven individual KLD categories are statistically (negatively) associated with tax avoidance. Thus, we estimate the following extended regression model: TAit ¼ a0 þ b1 CSRPERF1it þ b2 CSRPERF2it þ b3 CSRPERF3it þ b4 CSRPERF4it þ b5 CSRPERF5it þ b6 CSRPERF6it

102.99

þ b7 CSRPERF7it þ b8 BODIit þ b9 MTOBODit þ b10 BLOCKHLDit

(Two-tailed p value)

(0.01)

þ b11 AGEPUBit þ b12 CEOTENUREit

N

434

þ b13 CEODUALit þ b14 BIG4AUDITit þ b15 SIZEit þ b16 LEVit

Pseudo R2 (%) Wald c

2

18.48 %

Variable definitions: YEAR year dummy variable, coded 1 if the year falls within the specific year category, otherwise 0; and see Table 2 for other variable definitions Coefficient estimates with the t statistics in parentheses. Standard errors are corrected using the White (1980) procedure The p values are one-tailed for directional hypotheses and two-tailed otherwise * Significance at the 0.10 level ** Significance at the 0.05 level *** Significance at the 0.001 level

tax avoidant than smaller firms because they possess greater economic and political power compared with smaller firms and are able to reduce their tax burdens accordingly. LEV controls for capital structure effects. It has a significantly positive association with TA (p \ 0.01), which indicates that where firms rely more heavily on debt financing rather than equity financing to support their business operations, they will make use of the tax deductibility of interest payments to facilitate tax avoidance (Gupta and Newberry 1997). CINT controls for capital intensive effects. It has a significantly positive association with TA (p \ 0.05), which shows that capital intensive firms use accelerated depreciation tax incentives to assist tax avoidance (Stickney and McGee 1982). Finally, RDINT controls for R&D effects. It has a significantly positive association with TA (p \ 0.01), which indicates that firms

þ b17 CINTit þ b18 RDINTit þ b19 INVINTit þ b20 MKTBKit þ b21 ROAit þ b2228 YEARit þ eit

ð2Þ

where CSRPERF1 is the CSR performance rating of the firm for the community issues category; CSRPERF2 the CSR performance rating of the firm for the corporate governance issues category; CSRPERF3 the CSR performance rating of the firm for the diversity issues category; CSRPERF4 the CSR performance rating of the firm for the employee relations issues category; CSRPERF5 the CSR performance rating of the firm for the environment issues category; CSRPERF6 the CSR performance rating of the firm for the human rights issues category; and CSRPERF7 the CSR performance rating of the firm for the product issues category. We report our additional logit regression results in Table 6. For the extended regression model, the regression coefficient for CSRPERF1 is negative and significantly associated with tax avoidance (p \ 0.05). This is an interesting finding as this CSR category deals with the community relations aspect of the firm. For example, it includes CSR items pertaining to a firm’s charitable giving, support for housing, and support for education and volunteer programs. The CSRPERF1 category is relevant to society and taxation generally as it concerns the provision

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R. Lanis, G. Richardson

Table 6 Logit regression results—extended CSR model Variables

Predicted sign

TA

Intercept

?

4.904 (2.04)**

CSRPERF1

-

-0.362 (-1.87)**

CSRPERF2

-

-0.155 (-0.76)

CSRPERF3

-

-0.351 (-3.26)***

CSRPERF4

-

-0.142 (-1.21)

CSRPERF5

-

-0.030 (-0.25)

CSRPERF6

-

-0.480 (-1.64)**

CSRPERF7

-

-0.603 (-2.15)**

BODI

-

-0.730 (-1.76)**

MTOBOD

?

-0.160 (-0.93)

BLOCKHLD AGEPUB

?

0.414 (0.44) 0.007 (1.83)**

CEOTENURE

?

0.013 (0.57)

CEODUAL

?

0.050 (0.14)

BIG4AUDIT

-

-0.245 (-1.24)

SIZE

?

0.233 (2.16)**

LEV

?

0.450 (3.30)***

CINT

?

0.857 (1.91)**

RDINT

?

0.570 (1.95)**

INVINT

-

-0.441 (-0.19)

MKTBK

?

0.007 (0.36)

ROA

?

0.559 (0.41)

YEAR

?

Yes

Pseudo R2 (%)

23.90 %

Wald c2

133.18

(Two-tailed p value)

(0.01)

N

434

Variable definitions: CSRPERF1 the CSR performance rating of the firm for the community issues category; CSRPERF2 the CSR performance rating of the firm for the corporate governance issues category; CSRPERF3 the CSR performance rating of the firm for the diversity issues category; CSRPERF4 the CSR performance rating of the firm for the employee relations issues category; CSRPERF5 the CSR performance rating of the firm for the environment qualitative category; CSRPERF6 the CSR performance rating of the firm for the human rights issues category; CSRPERF7 the CSR performance rating of the firm for the product issues category; and see Tables 2 and 5 for other variable definitions Coefficient estimates with the t statistics in parentheses. Standard errors are corrected using the White (1980) procedure The p values are one-tailed for directional hypotheses and two-tailed otherwise * Significance at the 0.10 level ** Significance at the 0.05 level *** Significance at the 0.001 level

of public goods to society, which is directly funded (in part) by the corporate tax system (e.g., Freedman 2003). The regression coefficient for CSRPERF3 is negative and significantly associated with tax avoidance (p \ 0.01). This CSR category covers items related to diversity such as the

123

CEO (women or a member of a minority group), promotion (women and minorities), board of directors (women and minorities), work/life benefits (e.g., childcare, elderly care or flexitime), and women and minority contracting. Prior research shows that women with senior management roles (e.g., directorships) improve corporate performance (Adams and Ferreira 2009) and also reduce the likelihood of financial misstatements and fraud (Abbott et al. 2012). It could thus be expected that the presence of women in senior management roles assists the firm in mitigating the risk of tax avoidance, as is evidenced by our results. We also find that the regression coefficients for CSRPERF6, which relates to ‘‘human rights,’’ and CSRPERF7 which relates to ‘‘products’’ are both negative and significantly associated with tax avoidance (p \ 0.05). However, we observe that the regression coefficients for CSRPERF2, CSRPERF4, and CSRPERF5 are not significant. Finally, we also find that some of our control variables are significantly associated with tax avoidance (p \ 0.05 or better with predicted signs), including BODI, AGEPUB, SIZE, LEV, CINT, and RDINT. Sensitivity Analysis We employed a direct measure of tax avoidance based on tax disputes in our preceding empirical analysis. To improve the generalizability of our study’s findings, we also perform a sensitivity analysis of our main results utilizing several proxy measures of tax avoidance based on BTDs. In fact, prior research finds that BTDs are a more precise measure of tax avoidance compared with ETRs (see, e.g., Frank et al. 2009; Wilson 2009; Lisowsky 2010). Specifically, firms that are relatively successful at avoiding taxes are expected to sustain large temporary or permanent differences between their accounting and taxable income (Dyreng et al. 2008; Frank et al. 2009; Rego and Wilson 2012).17 Our first proxy measure of tax avoidance is based on total book-tax differences (BTDTOT), which reflects tax avoidance activities that generate both permanent and temporary differences between accounting and taxable income. As per Manzon and Plesko (2002), we evaluate the raw book-tax difference, which is calculated as pre-tax accounting income less taxable income scaled by lagged total assets. Taxable income is computed as income tax expense divided by the corporate statutory tax rate of 35 %. Prior research by Mills et al. (1998) and Wilson (2009) finds that larger BTDs are associated with higher proposed IRS audit adjustments in addition to the probability of tax avoidance. Thus, larger values of BTDTOT represent higher levels of tax avoidance. 17

For instance, depreciation expense can lead to temporary BTDs, whereas R&D tax credits can result in permanent BTDs.

Is CSR Performance Associated with Tax Avoidance? Table 7 OLS regression results—sensitivity analysis of base CSR model Variables

Predicted sign

BTDTOT

BTDRESID

Predicted sign

BTDTOT

BTDRESID

Intercept

?

-0.350 (-3.39)***

-0.206 (-3.26)***

CSRPERF1

-

-0.312 (2.11)**

-0.320 (-1.96)**

CSRPERF2

-

-0.030 (-0.13)

-0.011 (-0.30)

CSRPERF3

-

-0.299 (-1.99)**

-0.206 (-2.09)**

CSRPERF4

-

-0.005 (-1.05)

-0.013 (-1.07)

CSRPERF5

-

-0.008 (-1.08)

-0.005 (-0.45)

CSRPERF6

-

-0.019 (-2.03)**

-0.019 (-2.16)**

CSRPERF7

-

-0.049 (-2.06)**

-0.032 (-2.05)**

0.037 (1.01)

BODI

-

-0.036 (-3.38)***

-0.040 (-1.98)**

-0.047 (-1.03)

MTOBOD

?

-0.033 (-0.58)

-0.006 (-0.16)

-

-0.001 (-0.01)

-0.001 (-0.01)

?

0.380 (3.52)***

0.450 (3.41)***

CSRPERF

-

-0.083 (-2.10)**

-0.053 (-2.51)***

BODI

-

-0.053 (-3.15)***

-0.122 (-2.04)**

MTOBOD

?

-0.025 (-1.50)

-0.049 (-1.48)

BLOCKHLD

-

-0.001 (-0.01)

-0.001 (-0.01)

AGEPUB

?

-0.007 (-1.96)** 0.001 (0.07)

-0.006 (-2.04)** 0.002 (1.07)

CEODUAL BIG4AUDIT

? ? -

0.090 (0.23) -0.093 (-0.57)

Table 8 OLS regression results—sensitivity analysis of extended CSR model Variables

Intercept

CEOTENURE

453

SIZE

?

0.213 (3.78)***

0.192 (3.19)***

BLOCKHLD

LEV

?

0.716 (2.51)***

0.758 (3.34)***

AGEPUB

?

-0.005 (-2.02)**

-0.004 (-2.14)**

CINT

?

0.108 (1.91)**

0.077 (2.12)**

CEOTENURE

?

0.001 (0.05)

0.001 (0.26)

0.122 (2.47)***

CEODUAL

?

0.096 (0.02)

0.081 (1.05)

?

-0.055 (-0.09) 0.272 (3.57)***

-0.051 (-1.08) 0.207 (3.71)***

RDINT

?

0.097 (2.01)**

INVINT

-

-0.114 (-0.62)

-0.108 (-1.09)

MKTBK

?

0.001 (0.15)

0.001 (0.24)

BIG4AUDIT SIZE

ROA

?

0.030 (0.61)

0.054 (0.66)

LEV

?

0.740 (2.73)***

0.630 (3.40)***

YEAR

?

Yes

Yes

CINT

?

0.116 (2.04)**

0.085 (2.03)**

Yes

RDINT

?

0.147 (1.91)**

0.105 (2.04)**

-

-0.096 (-0.81)

-0.108 (-1.05)

INDSEC

Yes

Adj. R (%)

56.66 %

68.17 %

INVINT

F value

19.72

31.67

MKTBK

?

0.001 (0.70)

0.001 (-0.40)

ROA

?

0.059 (1.01)

0.046 (0.21)

YEAR

?

Yes

Yes

2

(Two-tailed p value)

(0.01)

(0.01)

N

434

434

Variable definitions: BTDTOT pre-tax accounting income less taxable income (i.e., where taxable income is computed as income tax expense divided by the corporate statutory tax rate of 35 %) scaled by lagged total assets; BTDRESID the book-tax differences residual computed based on the method advanced by Desai and Dharmapala (2006) (see Appendix A); INDSEC industry sector dummy variable, coded 1 if the firm falls within the specific GICS industry sector category, otherwise 0; and see Tables 2 and 5 for other variable definitions Coefficient estimates with the t statistics in parentheses. Standard errors are corrected using the White (1980) procedure The p values are one-tailed for directional hypotheses and two-tailed otherwise

INDSEC

Yes

Yes

Adj. R2 (%)

61.47 %

8.30 %

F value

19.82

4.06

(Two-tailed p value)

(0.01)

(0.01)

N

434

434

Variable definitions: see Tables 2, 5, 6, and 7 for other variable definitions Coefficient estimates with the t statistics in parentheses. Standard errors are corrected using the White (1980) procedure The p values are one-tailed for directional hypotheses and two-tailed otherwise * Significance at the 0.10 level

* Significance at the 0.10 level

** Significance at the 0.05 level

** Significance at the 0.05 level

*** Significance at the 0.001 level

*** Significance at the 0.001 level

Our second proxy measure of tax avoidance is denoted by the BTDs residual (BTDRESID) using the method developed by Desai and Dharmapala (2006).18 They argue that rather than just reflecting increased levels of tax 18

A description of the method developed by Desai and Dharmapala (2006) for calculating the BTDs residual is provided in ‘‘Appendix’’.

avoidance, BTDs could possibly also reflect earnings management activities in which income is adjusted to avoid reporting losses or to achieve performance benchmarks or remuneration-based objectives. In keeping with Desai and Dharmapala (2006), we adjust BTDs to control for the earnings management activities that could be responsible for the difference. More specifically, we remove the BTDs component attributable to earnings management to leave a

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454

residual value that is inferred to measure tax avoidance (Desai and Dharmapala 2006). As per Desai and Dharmapala (2006), larger values of BTDRESID signify higher levels of tax avoidance. Table 7 reports the ordinary least squares (OLS) regression results for the base CSR model using the BTD proxy measures of tax avoidance.19 For BTDTOT, we find that the regression coefficient for CSRPERF is negative and statistically significant (p \ 0.05), which provides additional support for our hypothesis. We also observe that several of the regression coefficients for the control variables (BODI, AGEPUB, SIZE, LEV, CINT, and RDINT) are statistically significant (p \ 0.05 or better, with predicted signs). In terms of BTDRESID, we also find that the regression coefficient for CSRPERF is negative and statistically significant (p \ 0.01). We also observe that some of the regression coefficients for the control variables (BODI, AGEPUB, SIZE, LEV, CINT and RDINT) are statistically significant (p \ 0.05 or better, with predicted signs). The OLS regression results for the extended CSR model are presented in Table 8. For BTDTOT, we find that the regression coefficients for CSRPERF1 (community relations), CSRPERF3 (diversity), CSRPERF6 (human rights), and CSRPERF7 (products) are negative and statistically significant (p \ 0.05), which provides further support for our prior regression results. We also observe that several of the regression coefficients for the control variables (BODI, AGEPUB, SIZE, LEV, CINT, and RDINT) are statistically significant (p \ 0.05 or better, with predicted signs). In terms of BTDRESID, we also find that the regression coefficients for CSRPERF1 (community relations), CSRPERF3 (diversity), CSRPERF6 (human rights), and CSRPERF7 (products) are negative and statistically significant (p \ 0.05), which provides extra support for our prior regression results. We also observe that some of the regression coefficients for the control variables (BODI, AGEPUB, SIZE, LEV, CINT, and RDINT) are statistically significant (p \ 0.05 or better, with predicted signs). Taken as a whole, we find that the results of our sensitivity analysis based on BTD proxy measures of tax avoidance are generally comparable to the main regression results reported in Tables 5 and 6.

19

Industry-sector (INDSEC) dummy variables defined at the twodigit GICS code level are also included as control variables in our OLS regression models as it is possible for tax avoidance to fluctuate across different industry sectors (Omer et al. 1993). We include nine INDSEC dummy variables in our OLS regression models: energy; materials; industries; consumer discretionary; consumer staples; health care; information technology; telecommunications; and utilities (omitted sector). No sign predictions are made for the INDSEC dummies.

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Conclusion This study investigates whether CSR performance is associated with tax avoidance. Our logit regression results demonstrate that the higher the level of CSR performance of a firm, the lower the likelihood of tax avoidance. Our results thus show that more socially responsible firms, in a matched sample of US firms, are likely to exhibit less tax avoidance. Finally, the results from our additional analysis indicate that the CSR categories community relations and diversity represent particularly important elements of CSR performance that reduce tax avoidance. Our study helps to answer a recent call made in the literature by Hanlon and Heitzman (2010, p. 146) for a detailed analysis of the association between CSR constructs and tax avoidance. This study also provides robust and generalizable evidence which shows that US firms with superior CSR performance are less likely to participate in tax avoidance. Finally, this study provides valuable insights for policymakers and regulators who seek to ascertain the circumstances under which the risk of tax avoidance is higher. This study is subject to potentially one limitation. Specifically, the sample is drawn from publicly listed US firms. Because of the limited availability of data, it was not possible to include unlisted US firms in our sample. Future research into CSR and tax avoidance could examine several important issues. First, a more thorough analysis could be carried-out in terms of which specific CSR activities are more closely associated with the firm’s tax policy, and why, as our results indicate, some CSR activities are more significant than others. Second, the role of ethics and corporate governance in driving CSR activities and corporate tax policy requires further examination. We encourage further research in this area. Acknowledgments The authors would like to thank Charl de Villiers, Neale O’Connor and David Smith for their helpful comments.

Appendix Description of Desai and Dharmapala’s (2006) method for computing the book-tax differences residual. Applying the Desai and Dharmapala (2006) methodology, taxable income is calculated as TIit income tax expense divided by the corporate statutory tax rate of 35 %. The BTD is calculated by subtracting TI from pre-tax accounting income (AI): BTDit = AIit - TIit. The BTD is scaled by lagged total assets. The sample is not restricted to firms with positive BTD as those firms with TI [ AI can and do use carry forward tax losses to reduce the amount of corporate taxes paid. Total accruals (TA) were calculated

Is CSR Performance Associated with Tax Avoidance?

455

for each firm in each year using a measure of total accruals developed by Healy (1985). TAs is considered to measure the earnings management component of BTD and is computed as follows: TAit ¼ EBEIit  CFOit

ð3Þ

where i is the firms 1–71, t the financial years 2003–2009, TA total accruals, EBEI pre-tax income, and CFO cash flows from operations. The following OLS regression is performed to account for the component of BTD attributable to earnings management: BTDit ¼ b1 TAit þ lit þ eit

ð4Þ

where BTD the book-tax difference scaled by lagged total assets, TA total accruals scaled by lagged total assets, l the residual, and e the error term. The residual value of BTD is considered by Desai and Dharmapala (2006) to reflect tax avoidance activity (TAA): TAAit = lit ? eit.

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