This paper analyzes the links between corporate tax avoidance, the growth of high-powered incentives for managers, and the structure of corporate governance. We develop and test a simple model that highlights the role of complementarities between tax sheltering and managerial diversion in determining how high-powered incentives influence tax sheltering decisions. The model generates the testable hypothesis that firm governance characteristics determine how incentive compensation changes sheltering decisions. In order to test the model, we construct an empirical measure of corporate tax avoidance - the component of the book-tax gap not attributable to accounting accruals - and investigate the link between this measure of tax avoidance and incentive compensation. We find that, for the full sample of firms, increases in incentive compensation tend to reduce the level of tax sheltering, suggesting a complementary relationship between diversion and sheltering. As predicted by the model, the relationship between incentive compensation and tax sheltering is a function of a firm's corporate governance. Our results may help explain the growing cross-sectional variation among firms in their levels of tax avoidance, the undersheltering puzzle,' and why large book-tax gaps are associated with subsequent negative abnormal returns.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
10471.
Length: Date of creation: May 2004 Date of revision: Handle: RePEc:nbr:nberwo:10471
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Find related papers by JEL classification: G30 - Financial Economics - - Corporate Finance and Governance - - - General H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
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Slemrod, Joel & Yitzhaki, Shlomo, 2002.
"Tax avoidance, evasion, and administration,"
Handbook of Public Economics,
in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 22, pages 1423-1470
Elsevier.
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Mihir A. Desai & Alexander Dyck & Luigi Zingales, 2004.
"Theft and Taxes,"
NBER Working Papers
10978, National Bureau of Economic Research, Inc.
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Mihir A. Desai & Alexander Dyck & Luigi Zingales, 2003.
"Theft and Taxes,"
International Tax Program Papers
0501, International Tax Program, Institute for International Business, Joseph L. Rotman School of Management, University of Toronto, revised Dec 2004.
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