Essays on corporate governance and tax policy

Abstract

Shareholders and non-shareholder stakeholders are not the decision makers of most corporate financial policies, including corporate tax policy. Yet, these parties are likely to play a substantial governance role in determining a firm’s tax policy. Presumably, by paying less tax, a firm may potentially enhance shareholder value, but it might have an adverse impact on other stakeholders’ interests. When a firm’s shareholders’ and other stakeholders’ governance roles are weakened or strengthened by exogenous shocks, its tax policy is likely to change. Understanding such dynamics helps explain the cross-sectional variations in tax policies across companies, an important question not yet well understood in the literature. This thesis consists of two chapters, investigating how firms change their tax policy when the power of shareholders (other stakeholders) are weakened (strengthened). The first chapter documents that firms tend to be less aggressive in tax policy when shareholders’ monitoring power over directors and officers is weakened. Employing the adoption of Universal Demand (UD) law in 23 U.S. states as an adverse shock to shareholder litigation, I find that firms subject to the UD law pay more income tax relative to control firms, particularly for firms with low institutional ownership or a CEO rewarded with fewer stock options before the law passage. Firms care less about the tax deductibility of CEO compensation after UD law passage, and more tax liabilities engender an adverse economic consequence. Therefore, risk-averse directors and officers (D&Os) are reluctant to engage in efficient but risky tax policy when shareholder monitoring is weakened. The second chapter shows that firms are more likely to pay their fair share of tax if D&Os are authorized to consider the interests of non-shareholder stakeholders. While paying less tax is deemed socially irresponsible, prior empirical evidence on the association between stakeholder orientation and tax policy is conflicting. Employing the staggered passage of constituency statutes (CS) that authorize D&Os to consider stakeholder interests in business decisions in the U.S., I find that firms incorporated in a state that passed a constituency statute pay more tax relative to control firms. The empirical results are robust to alternative explanations such as changes in earnings management. Therefore, strong stakeholder orientation leads to more tax payments.