Corporate Tax Avoidance: A Literature Review and Research Agenda: Corporate Tax Avoidance

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CORPORATE TAX AVOIDANCE: A LITERATURE REVIEW AND RESEARCH

AGENDA: CORPORATE TAX AVOIDANCE
Article in Journal of Economic Surveys · December 2019

DOI: 10.1111/joes.12347
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doi: 10.1111/joes.12347
CORPORATE TAX AVOIDANCE: A LITERATURE

REVIEW AND RESEARCH AGENDA
Fangjun Wang* , Shuolei Xu and Junqin Sun
Xi’an Jiaotong University
Charles P. Cullinan
Bryant University
Abstract. Tax avoidance can range from reduction of the corporate tax burden by legitimate use
of tax rules to violation of tax laws. In this paper, we endeavor to synthesize the major findings
of tax avoidance research from the accounting and finance literatures over the past ten years. We
consider theoretical developments and the related empirical findings about the interconnected issues
of measuring tax avoidance, and the possible causes and outcomes of corporate tax avoidance. We
present some ideas for further research to examine underexplored topics regarding tax avoidance.
Keywords. Agency theory; Corporate governance; Corporate tax avoidance; Firm value
1. Introduction
Taxation is the most important form of governmental fiscal revenue and is one of the most important
costs for individual firms. Tax avoidance by a firm includes legal tax planning and illegal tax evasion.
Tax planning means reducing a firm’s tax burden through investments and structuring business activities
within the scope of the tax law. Tax evasion goes beyond avoidance to the point whether a firm evades
their tax obligations through violations of tax laws and related regulations. Hanlon and Heitzman (2010)
define tax avoidance as a closed set of all tax planning strategies. One end of the closed set is legitimate
tax avoidance while the other end is noncompliance, evasion, etc. Because empirical studies often cannot
clearly distinguish between tax planning and tax evasion, we adopt the definition proposed by Dyreng
et al. (2008) which refers to all transactions that reduce companies’ tax obligations as being tax avoidance.
Figure 1 present the continuum of tax avoidance.
Earlier avoidance research tended to focus on firm-level factors that may result in tax avoidance (i.e.,
determinants) (Shackelford and Shevlin, 2001). More recent studies have also considered the outcome
of tax avoidance, including economic consequences. These economic consequences can differ among
managers, the firm, and its shareholders due to agency problem, which is the focus of much recent work
on tax avoidance.
Tax avoidance involves an organization retaining cash resources within the company that would
otherwise go the government. These resources may lead to enhanced firm (and thereby shareholder)
value. However, this tax avoidance/shareholder value link can be impaired by agency problems
related to the separation between shareholders and managers for a number of reasons. First, this
∗ Corresponding author contact email: wangfangjun@xjtu.edu.cn; Tel: +86 189 9128 9939.
Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

C 2019 John Wiley & Sons Ltd.
794 WANG ET AL.
How is aggressive of the activity?
Corporate tax avoidance
Legitimate tax avoidance Tax evasion

Figure 1. Corporate Tax Avoidance Proposed by Hanalon and Heitzman (2010). [Colour figure can be viewed
at wileyonlinelibrary.com]
shareholder/management separation may provide opportunities for managers to take advantage of tax
avoidance behaviors to engage in self-serving behavior which can harm the firm’s value. Second, firms
may disguise their tax-related actions by covert and complicated transactions to avoid the exposure of tax
avoidance to the tax authority; such obfuscation can also reduce transparency to shareholders. Third, tax
avoidance can involve long-term reputation losses. Fourth, tax avoidance may be inconsistent with socially
responsible behavior (Sikka, 2010), which may be of importance to some shareholders. Shareholders may
also have preferences for social responsible companies (e.g., MacKey et al., 2007).
In this paper, we review the research on tax avoidance from the accounting and finance literatures.
The accounting and finance literatures are appropriate to study because accounting researchers may
have a comparative advantage in interpreting and analyzing income measurements and disclosures of
tax payments, etc. from the financial statements. The finance literature has developed agency theories
that may help to explain the divergent interests of managers and shareholders, and these theories have
recently been applied to tax avoidance issues. Synthesizing the existing tax avoidance literature can
identify opportunities to extend existing theories and provide more empirical evidence.
In this paper, we review research findings related to the following questions (see Figure 2): What are
the motivations of corporate tax avoidance (Section 2)? How is tax avoidance measured (Section 3)?
Which factors affect corporate tax avoidance (Section 4)? And how does corporate tax avoidance affect
corporate decisions and behaviors (Section 5)? The paper closes with the identification of some areas of
tax avoidance where further research may be useful (Section 6).
2. Motivations of Corporate Tax Avoidance
2.1 Financial Interest Motivation

Tax avoidance involves withholding resources from the government and retaining the resources within
the firm, which can then be used to enhance firm value. Shackelford and Shevlin (2001) mention that
the objective of effective tax planning should be to maximize the firm value (rather than minimizing
tax payments). Prior studies on tax avoidance generally view tax avoidance as a form of value creation
behavior that is designed to maximize shareholder wealth.
Earlier tax avoidance literature was premised on the idea that reduced taxes would benefit shareholders,
and firm managers would therefore pursue these tax avoidance strategies. However, managers’ tax
decisions may reflect their own (i.e., the agent’s) interests rather than the interests of the shareholders (i.e.,
the principal’s interests). Crocker and Slemrod (2005) proposed that management’s and shareholders’
interests in taxes can differ if the penalties for tax illegal tax evasion are borne by executives making
tax decisions rather than being borne by shareholders, and that executive compensation contracts can be
designed to more effectively align the interests of shareholders and managers regarding taxes. Chen and
Chu (2005) examine the complications that can arise in contracting with managers to engage in illegal
tax evasion. Tax evasion may be beneficial to risk-neutral shareholders (if the evasion is not detected),
CORPORATE TAX AVOIDANCE 795
Figure 2. The Research Framework of Corporate Tax Avoidance.
but the penalty for tax evasion (including penalties) can be imposed on the executive making the decision
personally. A risk averse manager would thus need to be compensated for the personal risk they assume.
This situation would result in an incomplete compensation contract, as contracts involving illegal behavior
are not enforceable. These papers lay the theoretical foundation for tax-avoidance agency theory.
Building on tax-avoidance agency theory, Desai and Dharmapala (2006) and Desai et al. (2007) note
that firms often create sophisticated transactions to avoid detection by tax authorities. In addition to hiding
resources from taxation authorities, these sophisticated transactions can hide resources from shareholders,
potentially allowing managers to use these resources for their own purposes (e.g., to extract economic
rents from the company). Complex tax avoidance strategies can also aggravate information asymmetry
between management and shareholders and increase the supervision costs of shareholders. Consistent
with this theory, Desai et al. (2007) find that managers of Russian oil firms can personally benefit from
their companies’ tax avoidance transactions. Contrary to the findings of Desai et al. (2007) in Russia,
Blaylock (2016) does not find a significant relationship between tax avoidance and rent extraction by
managers among USA firms.
A more complicated picture emerges in China, where governments can serve the dual roles of both
tax collecting authorities and controlling shareholders in some companies. As tax collectors, they are
interested in maximizing tax revenue; as shareholders, their interests are in reducing taxes. Tang et al.
(2017) examined these potentially conflicting roles surrounding a change in the taxation-sharing ratio
796 WANG ET AL.
between the central and local governments in China. Before the change, all tax revenue collected by the
local government stayed with the local government. After the change, the tax collections from the local
government were shared equally with the central government in Beijing. They find that local-government
controlled firms engage in more tax avoidance in the post-event period than in the pre-event period. Tang
et al.’s (2017) findings suggest that intergovernmental conflicts can have an effect on firms’ tax avoidance
strategy when the government is also a shareholder.
2.2 Social Responsibility Motivation

Individual tax avoidance behavior can be influenced by the intrinsic motivation of citizen responsibility
(Slemrod, 2004); corporate tax avoidance may also be affected by corporate social responsibility (CSR).
The relationship between CSR and tax avoidance can be viewed in two ways. One perspective suggests
that paying taxes is a basic social obligation of a company, and that taxes can be used to enhance social
welfare (Sikka, 2010). Therefore, tax avoidance is socially irresponsible, and more socially responsible
firm will engage in less tax avoidance (Christensen and Murphy, 2004; Lanis and Richardson, 2013; Hoi
et al., 2013). An alternative perspective suggests that paying taxes is not a part of CSR, but a cost of
doing business (Davis et al., 2016). Davis et al. (2016) point out that tax avoidance can generate resources
which can be used to invest in socially responsible activities, such as infrastructure investment and job
creation.
In summary, corporate tax avoidance can reduce a firm’s tax payments, increasing cash flow, which
could increase firm value. However, agency theory suggest that managers may divert the cash created by tax
avoidance for their own benefit and that compensation contracts may not be able to avoid such diversions.
Therefore, agency theory suggest that managerial rent-extraction could decrease the likelihood that tax
avoidance would enhance firm value. The social responsibility perspective suggests that tax avoidance
may be inconsistent with an organization’s social responsibility to society. Hence, corporate tax avoidance
may be subject to the dual influences of financial incentives and social responsibility incentives.
3. Measurement of Corporate Tax Avoidance

The two most common measures of corporate tax avoidance are those based on effective tax rates (ETR)
and those based on difference between financial reporting (book) income and taxable income.1 A third
measure (disclosure of penalties for underpayment of taxes) has recently been used in China.
3.1 Effective Tax Rate

The corporation’s ETR is a common indicator of a firm’s tax burden. Differences between the ETR and the
statutory rate can arise because income is measured differently under financial reporting standards2 than
under taxation rules. Some of these differences between financial-reporting income and taxable income
are temporary, with the long-run taxable income equaling the long-run financial reporting income. For
example, depreciation expense for financial reporting purposes is computed based on an asset’s estimated
useful life. The depreciation deduction (for tax purposes) related to an asset is based on an accelerated
cost recovery systems in the United States (and other countries) which results in larger depreciation
deductions in the earlier years of an asset’s life (and thus lower taxable income) to encourage investment.
Other differences between financial reporting income and taxable income are permanent. For example,
in the United States, interest income on municipal bonds is included in income for financial reporting
purpose, but is generally not subject to federal income taxation. Both temporary and permanent differences
can result in differences between ETR and statutory tax rates. A difference between effective and statutory
rates can also arise due to preferential tax treatment of certain types of income, such as lower tax rate for
long-term capital gains.
There are two common measures of ETR: the GAAP ETR and cash ETR. GAAP ETR is computed
as total income tax expense divided by pre-tax accounting income (Rego, 2003; Hanlon and Heitzman,
2010), with both measures available on the income statement. Cash ETR uses cash taxes paid, rather
than income tax expense as the numerator. Tax expense and taxes paid will differ due to temporary
differences. Tax expense used in the GAAP ETR reflects the total, long-run, tax payments related to the
current year’s income, regardless of when the tax was, or will be, paid. GAAP ETR thus accounts for
the long-run equivalence of book and taxable income if all the difference are temporary (such as with
accelerated depreciation deductions for tax purposes). The cash ETR reflects only the tax payments made
in the current year, and this would be lower than GAAP ETR if book income were higher than taxable
income. A complication arises if the pre-tax income is negative, in which case measures of ETR cannot
effectively capture corporate tax avoidance behavior. To avoid year-to-year volatility of annual tax rates
and negative income, Dyreng et al. (2008) use a long-run cash ETR based on the sum of taxes paid over
ten years divided by the sum of pre-tax income over the same period.3 The long-term period measure
can limit the effects of temporary differences in measuring tax avoidance behavior when the Cash ETR
is compared to the statutory rate.
3.2 Book-Tax Differences

Book-tax differences (BTD) are based on differences between income measured for financial reporting
purposes and taxable income. Mills (1998) documents that firms with large BTD are more likely to be
audited by the USA Internal Revenue Service (IRS) and have larger proposed audit adjustments. Wilson
(2009) finds that BTD are larger for firms accused of engaging in tax shelters than for a matched sample
of non-accused firms. These studies suggest that BTD may capture corporate tax avoidance behavior.
Because taxable income is not directly observable, the calculation of BTD first estimates taxable income
(measured as current income tax expense divided by the statutory tax rate), then subtracts taxable income
from accounting earnings. However, BTD can be affected by earnings management, tax laws, differences
in accounting standards, and other factors (Graham et al., 2012), making BTD a potentially noisy measure
of corporate tax avoidance.
Desai and Dharmapala (2006) suggest that BTD may not only indicate tax avoidance behavior, but
may also involve earnings management. They propose measuring multiple components of earnings
management by regressing total BTD on total accruals. Their estimation used using panel data with
firm fixed effects, so the time-invariant firm-specific component is absorbed. In their BTD model, the
firm-year’s deviation from the average residual measures the corporate tax avoidance behavior that cannot
be explained by earnings management. However, Frank et al. (2009) argue that the measure Desai and
Dharmapala (2006) propose does not control for nondiscretionary items, such as property, plant and
equipment, and intangible assets. Frank et al. (2009) estimate the discretionary portion of the permanent
differences, which is computed as the difference between total BTD and temporary tax-book differences.
3.3 Measure Based on Disclosure of Tax Enforcement Actions

Chow et al. (2019) measured tax evasion by capturing the disclosure of financial statement adjustments
associated with tax enforcement actions. These actions result in the company having to pay more in taxes
for previous years resulting from investigations and/or audits by taxing authorities. Chow et al. (2019)
measures illegal tax evasion, and not necessarily instances of legal tax avoidance. Chow et al. (2019) note
that this measure is unique to China due to requirements that Chinese public companies must disclose all
detected tax evasions.
798 WANG ET AL.
Prior and current research employs a variety of metrics to measure corporate tax avoidance. Not all
measures may be equally appropriate for a specific research question, and the different measures could
yield different results. For example, Chow et al. (2019) using a direct measure of illegal tax evasion
find that state-owned enterprises are more likely to engage in tax evasion than non-SOEs. In contrast,
Bradshaw et al. (2019) used ETR measures and found that SOEs are less likely to engage in tax avoidance
than non-SOEs. These contrasting results indicate that different measurements of tax avoidance could
result in materially different results.
4. The Determinants of Corporate Tax Avoidance

In this section, we discuss the research on factors that may be related to a company’s choice to engage
in tax avoidance (i.e., potential determinants of corporate tax avoidance). Factors related to corporate tax
avoidance examined in the literature relate to both internal company characteristics, such as corporate
governance, and external characteristics, such as the environment within which the company operates.
4.1 Internal Company Characteristics That May Predict Tax Avoidance Behavior
Earlier research on internal factors focused on basic characteristics, such as firm size, business strategy,
and industry classification (e.g., Rego 2003; Wilson, 2009; Lisowsky, 2010). In more recent years, tax
avoidance literature has incorporated corporate governance characteristics that are designed to reduce
agency conflicts (Hanlon and Heitzman, 2010). Table 1 lists the main internal determinants of corporate
tax avoidance in literatures.
4.1.1 Firm-Level Characteristics

Three firm-level characteristics considered as predictors of corporate tax avoidance are company size,
strategy, and multinational operations. Larger companies have been found to engage in more tax avoidance
(Rego, 2003). Although big firm may face more scrutiny, they also may have the resources and larger
monetary incentives to engage in tax avoidance and may be able to influence the political process (Wilson,
2009; Lisowsky, 2010). Higgins et al. (2015) results indicate that a firm’s business strategy (based on Miles
and Snow’s [1978, 2003] business strategy theory) is associated with the level of tax avoidance. They find
that prospector-type firms engage in more tax avoidance, consistent with prospectors’ greater appetite
for risk and uncertainty. Defender-type firms, which prefer to reduce exposure to risk and uncertainty,
engage in less tax avoidance. Robinson et al. (2010) find that tax departments evaluated as profit centers
have greater propensity for tax avoidance behavior. Multinational firms may have more opportunity to
engage in tax avoidance through structured transactions by which they shift taxable income to lower-tax
jurisdictions (Collins and Shackelford, 1999; Rego 2003; Hope et al., 2013).
4.1.2 Ownership Structure

Different kinds of ownership may have distinct impact on corporate tax planning (Desai and Dharmapala,
2008). For example, firms with concentrated family ownership may be more sensitive to risk exposure,
and their non-tax costs (including penalties and reputational costs) may be higher. Consistent with these
ideas, Chen et al. (2010) find that family-controlled firms engage in less tax avoidance than firms with
more dispersed ownership. McGuire et al. (2014) suggest that firms with dual class share structures have
lower level of tax avoidance; because the voting rights are controlled by insiders, management may feel
less pressure from outside shareholders to engage in tax avoidance behaviors.
Table 1. Internal Determinants of Corporate Tax Avoidance.
Determinants Main findings Papers
Firm-level Firm size Firm size is positively related Wilison (2009); Lisowsky
characteristics to tax avoidance (TA). (2010)
Business strategy Different business strategies Higgins et al. (2015)
result in variation of TA.
Multinational Multinationals engage in Rego (2003); Hope et al.
greater TA. (2013)
Ownership Family firms Family firms engage in less Chen et al. (2010)
structure TA.
Institutional Institutional ownership is Desai and Dharmapala
ownership positively related to TA. (2009); Khan et al.
(2017)
Institutional ownership is Khurana and Moser
negatively related to TA. (2013)
Executives’ Narcissism CEO narcissism is positively Olsen and Stekelberg
personal related to the likelihood of (2016)
characteristics engaging in aggressive TA.
Conservatism Management conservatism is Christensen et al. (2015)
negatively related to TA.
Military experience Manager’s military Law and Mills (2017)
experience can restrain TA.
Personal tax Management personal tax Chyz (2013)
aggressive aggressive is positively
associated with TA.
Executive Compensation CEO compensation is not Phillips (2003);
compensation associated with TA. Armstrong et al. (2012)
plans
CEO compensation is Gaertner (2014)
positively related to TA.
Equity-based There is a positive Rego and Wilson (2012);
incentive relationship between Armstrong et al. (2015)
equity incentive and TA.
There is a negative Desai and Dharmapala
relationship between (2006)
equity incentive and TA.
Internal governance Board directors Board independence and Lanis and Richardson
sophistication are (2011); Armstrong
positively related to TA. et al. (2015)
Internal audit Independence of the internal Richardson et al. (2013)
committee audit committee is
negatively associated with
TA.
Internal control Internal control quality allow Bauer (2016);
firms to engage in greater Gallemore and Labro
TA. (2015)

800 WANG ET AL.
The role of institutional shareholders has not produced consistent results in the tax avoidance literature.
Institutional investors with material holdings of a firm’s shares may encourage managers to maximize
shareholder wealth, including by engaging in tax avoidance. Chen et al. (2010) find that family firms
with more long-term institutional shareholding engage in more tax avoidance than family firms with
less long-term institutional shareholding. Khurana and Moser (2013) suggest that long-term institutional
investors may prefer greater transparency (which can be inconsistent with tax avoidance strategies), and
may be unwilling to bear the longer-term costs of tax avoidance if such behavior is discovered. They
find results consistent with their theory: firms with more long-term institutional shareholdings engage
in less tax avoidance. Khan et al. (2017) suggest that there is an increase in tax avoidance associated
with increased institutional ownership following inclusion of a company in the Russell 2000 inclusion.
Their findings of a positive association between institutional shareholdings and tax avoidance are different
from those of Khurana and Moser (2013). Khan et al. (2017) attribute the difference in results to their
controlling for endogeneity through the use of the change in institutional ownership following inclusion
in the Russell 2000 index.
4.1.3 Executives’ Personal Characteristics

Executive management sets the “tone at the top” in the organization. Upper echelons theory suggests
that organizational choices are at least partially a reflection of personal characteristics of firm’s top
management. Dyreng et al. (2010) track the movements of 908 executives (including CEOs and CFOs)
of USA listed firms and find that the individual executives have a significant influence on the level of
tax avoidance of firms employing the executives. More recent research has considered which specific
aspects of executive’s personal characteristics may explain tax avoidance. Olsen and Stekelberg (2016)
find that CEO narcissism is positively related to the likelihood of a CEO’s firm engaging in aggressive
tax avoidance, while Christensen et al. (2015) find that managerial conservatism is negatively related to
corporate tax avoidance.2 Law and Mills (2017) argue that managers with military experience engage
in less tax avoidance because aggressive tax avoidance may violate common values. Chyz (2013) find a
positive correlation between managers’ aggressive personal income tax behaviors and the aggressiveness
of the tax policy of the company for which the managers work.
4.1.4 Executive Compensation Plans

If executive compensation aligns the interests of managers and shareholders, and if shareholders favor
tax avoidance to increase firm value, then this theory predicts a positive relation between incentive
compensation and tax avoidance. Providing mixed results for this notion, Phillips (2003) finds that
incentive compensation plans based on after-tax performance for CEOs is not associated with tax
avoidance, but similar compensation plans for business unit managers can provide motivations for
corporate tax avoidance. Consistent with Phillip’s (2003) results among CEOs, Armstrong et al. (2012)
also do not observe a significant relationship between CEO compensation and corporate tax avoidance.
Armstrong et al. (2012) do find that the compensation of tax executive is significantly associated with tax
avoidance. Gaertner (2014) finds a positive relationship between the compensation of CEOs and lower
ETR among companies in which CEO compensation is based on after-tax performance (Gaertner, 2014).
Equity-based incentive compensation (e.g., stock options) may induce managers to adopt less risk-
averse strategies, such as tax avoidance. Rego and Wilson (2012) and Armstrong et al. (2015) find
that equity incentives can encourage management to adopt more tax avoidance strategies. However,
Sanders and Hambrick (2007) caution that stock options may encourage excess risk taking, which may be
consistent with Armstrong et al. (2015)’s finding that the equity compensation/tax avoidance relationship
is relationship is stronger for firms with particularly higher levels of tax avoidance.
4.1.5 Internal Governance

The link between tax avoidance and firm value proposed in the section above may be attenuated by the
free cash flow problem identified by Jensen (1986), in which managers use available cash for sub-optimal
purposes. Because tax avoidance can increase the available cash, tax avoidance may not be an optimal
strategy if the resources are more likely to be misused by managers (Desai and Dharmapala, 2006). More
strongly governed firms may avoid this free cash flow problem by eschewing tax avoidance. Consistent
with this view, research finds that Australian companies with a higher proportion of outside directors
practice less tax avoidance (Lanis and Richardson, 2011), and that the independence of the internal audit
committee is negatively associated with tax avoidance (Richardson et al., 2013). Armstrong et al. (2015)
find a more complex pattern: board independence and financial sophistication are positively related with
tax avoidance for low levels of tax avoidance, but negatively related to tax avoidance for high levels
of tax avoidance. They suggest that the corporate governance mechanism can mitigate agency problem
at extreme levels of tax avoidance. Bauer (2016) analyzes the association between tax avoidance and
internal control weakness (ICWs). Their results provide some evidence that internal control weaknesses
are negatively associated with tax avoidance, and they find that firms’ tax avoidance activity increases
after remediation of their tax-related ICWs. Consistent with Bauer (2016), Gallemore and Labro (2015)
find that firms with better internal controls and internal information quality pursue more tax avoidance.
4.2 External Determinants

Table 2 lists the main external determinants of corporate tax avoidance in literatures.
4.2.1 Institutional Factors

Neoinstitutional economic theory argues that a society’s institutional framework can influence firm
behavior. The institutional framework incudes laws, regulations and other informal institutions, such
as societal values. Corporate tax is subject to legal and public scrutiny (Chen et al., 2010), including
monitoring and inspection by taxation authorities (Mascagni, 2018), which can levy penalties on those
inappropriately avoiding taxes (Torgler, 2002). Desai et al. (2007) find that Russia firms increased their tax
payments and decreased connected transactions after the initial election of Putin as the Russian president,
an outcome they suggest resulted from an increase in tax enforcement. Hoopes et al. (2012) suggest that
USA public firms engage in less aggressive tax planning when IRS (Internal Revenue Service) monitoring
is more strict and Atwood et al. (2012) find a negative relationship between strength of home country
enforcement and corporate tax avoidance.3 Other indirect enforcement mechanism may also affect tax
avoidance. For example, Kubick et al. (2016) find that companies receiving a tax-related comment letter
from the Securities and Exchange Commission (SEC) reduced their tax avoidance behavior.
4.2.2 External Markets

In product markets, firms need to compete with industry peers to obtain market share. Due to the
comparative advantages, product market leaders can have a better understanding of the extent to which
tax avoidance strategy will be beneficial and have been found to engage in greater tax avoidance (Kubick
et al., 2015). However, Austin and Wilson (2017) argue that the firms with valuable brands engage in less
tax avoidance because of reputational concerns. Due to the managerial labor market, management may
engage in more aggressive tax avoidance to enhance the firm’s performance, to consolidate their positions
and to increase their value in the labor market (Kubick and Lockhart, 2016).
802 WANG ET AL.
Table 2. External Determinants of Corporate Tax Avoidance.
Determinants Main Findings Papers
Institutional Tax Tax enforcement can decrease Desai et al. (2007); Hoopes
factor enforcement corporate tax avoidance. et al. (2012); Atwood
et al. (2012)
Other regulation The receipt of SEC Kubick et al. (2016)
tax-related comment letters
decrease TA.
External market Product market Product market leaders Kubick et al. (2015); Austin
engage in greater TA; firm and Wilson (2017)
with valuable brands
engage in less TA.
Labor market Manager market encourages Kubick and Lockhart (2016)
firms to engage in TA.
Financial Financial constraints is Edwards et al. (2016);
market positively related to TA. Wang (2016)
Tax incidence Firms with lower corporate Dyreng et al. (2019)
income taxes engage in
less tax avoidance
External Media attention Media attention is negatively Tian et al. (2016);
governance related to TA. Kanagaretnam et al.
(2018)
Public Public pressure is negatively Dyreng et al. (2016); Hope
disclosure related to TA. et al. (2013)
External audit Higher audit quality limits McGuire et al. (2012);
TA. Klassen et al. (2016)
Purchasing of tax service
promote TA.
Social networks Board ties Greater board ties with Brown and Drake (2014);
low-tax firms can reduce Hope et al. (2013)
firm’s tax expense.
Political ties Political connections are Kim and Zhang (2016)
positively related to TA.
Supplier ties A good relationship with Cen et al. (2017)
suppliers can help firms
engage in greater TA.
Economists generally agree that the economic burden of corporate taxes is not entirely borne by
shareholders, but can also be borne by employees and/or customers. Taxes can be borne by employees
through lower wages, by customers in the form of higher prices, and by shareholders through lower
after-tax profits. Dyreng et al. (2019) suggest that the cost of taxes for firms with limited market
power are more likely to be borne by shareholders as the company cannot impose the tax burden
on customers; firms with limited market power will therefore be more likely to engage in tax
avoidance.
When the external financing environment is deteriorating, corporations may engage in more tax
avoidance to create internal cash flows to fund operations. Edwards et al. (2016) find that firms facing
increasing financial constraints engage in greater tax avoidance. Wang (2016) finds when external funding
may be scarcer due to a financial crisis, the level of Chinese firms’ tax avoidance is higher.
4.2.3 External Governance

Outside investors can use their expertise and experience to restrain the rent-seeking of managers, and
decrease the degree of tax avoidance (Khurana and Moser, 2013). Media exposure of aggressive tax
behaviors could increase the probability of detection and can impose reputational costs on companies and
firms subject to greater media scrutiny have been found to have lower levels of tax avoidance (Tian et al.,
2016; Kanagaretnam et al., 2018).
Public disclosure of financial information may also influence corporate tax strategies, as taxation
authorities and other groups can read the financial statements and disclosures when assessing whether
companies are paying their appropriate taxes. When the United Kingdom required companies to disclose
their use of subsidiaries in tax havens, companies with such subsidiaries decreased their level of tax
avoidance (Dyreng et al., 2016). Hope et al. (2013) suggest that firms discontinuing the disclosure of
geographic earnings in response to SFAS 131 had lower ETR after removing this information from their
financial statements, consistent with the lack of transparency encouraging more tax avoidance. Financial
Interpretation No. 48 (FIN 48) requires the public disclosure of income tax reserves related to tax shelters
and Lisowsky et al. (2013, p. 1698) “show that the reserve is a suitable summary measure for predicting
tax shelters.”
The nature of the tax preparer may also influence the level of tax avoidance. Klassen et al. (2016) find
that firms preparing their own tax returns have the most tax avoidance, but those using a Big 4 accounting
firm for both audit and tax services had lower levels of tax avoidance. However, McGuire et al. (2012)
argue that firms purchasing tax services from outside audit firms with tax planning expertise may engage
in greater tax avoidance.
4.2.4 Social Networks

The social network structure may also be related to corporate tax avoidance. Brown and Drake (2014)
suggest that board ties can promote the sharing of corporate tax avoidance knowledge among firms. Their
results indicate that firms have lower ETR when directors on their boards also serve on the boards of other
companies with low tax rates. Kim and Zhang (2016) find that political connections between businesses
and governmental officials help to lower the probability of being investigated by tax authorities; firms
with political connections can therefore more safely engage in tax avoidance. Li and Xu (2013) find
that Chinese firms with more political status pursue more tax avoidance. Firms’ close customer-supplier
relationships can lower the marginal costs of implementing tax avoidance strategies through supply chains,
which may allow both principal customers and suppliers to engage in greater tax avoidance (Cen et al.,
2017).
5. The Consequences of Corporate Tax Avoidance

Corporate tax avoidance may produce a series of potential economic consequences. These consequences
may be direct, such as increasing the cash flow and reducing the tax burden of firms, or indirect, such as
changing the firm’s capital structure (Graham and Tucker, 2006). If illegal tax avoidance is detected, firms
and managers may face fines, litigation and reputation consequences. The influence of tax avoidance on
804 WANG ET AL.
Table 3. Consequences of Corporate Tax Avoidance.
Consequences Main findings Papers
Corporate value Tax avoidance can reduce cash outflow, Graham and Tucker (2006)
and increase firm value.
Tax avoidance associated with Desai and Dharmapala (2009)
opportunistic behaviors, and
increased agency cost, which
decrease firm value.
Tax avoidance is positively associated Hasan et al. (2014)
with debt cost.
Tax avoidance is negatively associated Goh et al. (2016)
with equity cost.
Stock market reaction The stock price declines when firm’s Hanlon and Slemrod (2009)
tax avoidance is disclosed.
Market responded negatively to Frischmann et al. (2008)
subsequent news of a Senate inquiry
into UTB disclosures.
There is a negative reaction to the data O’Donovan et al. (2019)
leak of Panama Papers.
Firm risk Tax avoidance does not increase future Guenther et al. (2017)
firm risk.
Tax avoidance is positively related to Kim et al. (2011)
firm risk.
Accounting and auditing Tax avoidance is positively related to Frank et al. (2009)
consequences financial reporting aggressiveness.
Tax avoidance is positively associated Lennox et al. (2013)
with the possibility of committing
accounting fraud.
Tax Avoidance is positively associated Donohoe and Knechel (2014)
with audit fees.
firms may relate to the firm’s value, risk, share price, financial disclosure quality, and audit pricing. The
possible consequences of corporate tax avoidance are summarized in Table 3.
5.1 Corporate Value

The influence of tax avoidance on corporate value has produced mixed results in the literature. Desai and
Dharmapala (2009) found no significant relationship between tax avoidance and firm value, which they
believe arises because of managerial opportunistic behavior using the cash available from tax avoidance.
There may also be indirect effects of tax avoidance on firm value via financing costs. Hasan et al. (2014)
argue that creditors will not enjoy the benefits of tax avoidance, because their return is fixed. Because
tax avoidance may increase the business risk of the company, banks will ask their clients for higher loan
spreads in order to remediate the risk. Consistent with this theory, Hasan et al. (2014) find that corporate
tax avoidance is positively related to debt financing costs. Shareholders, as residual claimants to the
business, enjoy more upside from tax avoidance and Goh et al. (2016) find that firms avoiding taxes have
a lower cost of equity capital.
5.2 Stock Market Reaction

The stock market could react to the disclosure of tax avoidance. Hanlon and Slemrod (2009) found a
negative market reaction of 1.04% surrounding disclosure of firms’ involvement in tax shelters. Using the
implementation of FIN 48 (requiring disclosure of tax shelter activity). Frischmann et al.’s (2008) find
that the market responded negatively when a Senate inquiry suggested an increase in taxes for firm using
tax shelters. The Panama Papers leak disclosed the name of many companies engaging in questionable
tax shelters. O’Donovan et al. (2019) document a total loss in market value of $174 billion among the
companies implicated by the Panama papers.
5.3 Firm Risk

Tax avoidance may increase uncertainty with respect to future tax payments, because tax avoidance
strategies (such as shifting income to future periods) may be difficult to sustain. However, Guenther
et al.’s (2017) results indicate that tax avoidance is not associated with either future tax rate volatility or
with future firm risk.
Tax avoidance often involves more complex organization structures, creating “masks for opportunistic
behaviors,” such as managerial rent extraction (Kim et al. 2011, p. 639). When these opportunistic
behaviors by management are unmasked, there is a significant likelihood of a material decrease in the
price of the stock. Thus, Kim et al. (2011) argue that tax avoidance can increase the longer-run risk of a
precipitous fall in the firm’s stock price.
5.4 Accounting and Auditing Consequences

According to the agency theory, managers may conduct earnings management under the cover of tax
avoidance, which could thereby negatively affect the quality of financial reporting. Using performance-
adjusted earnings to measure the quality of corporate financial reporting, Frank et al. (2009) find that the
tax avoidance is positively related with the aggressiveness of financial reporting. Lennox et al. (2013),
in contrast, suggest that firms with greater tax avoidance are exposed to more stringent scrutiny, and
thus will be less susceptible to accounting fraud. With regard to audit issues, corporate tax avoidance
increases a firm’s complexity and aggressive tax avoidance strategies can also increases the reputation risk
of auditors, both of which would increase audit fees. Consistent with these ideas, Donohoe and Knechel
(2014) find that tax avoidance is positively related to audit fees.
6. Future Research Opportunities

Tax avoidance results in firms retaining resources that otherwise would be remitted to the government.
These resources could be used for productive corporate purposes, which would increase firm value.
Alternatively, the resources could be used to benefit managers at the expense of shareholders (i.e.,
managers may extract rents from the company based on the extra resources available from tax avoidance)
which could mitigate the potential for tax avoidance to enhance firm value. In this section, we propose
some areas for further research on tax avoidance.
806 WANG ET AL.
6.1 Type II Agency Costs

Most of the research on tax avoidance and the potential conflicts between managers and shareholder has
been premised on Type 1 agency costs, which involve a conflict between widely dispersed shareholders
and self-motivated managers. If shareholders are not widely dispersed, a different picture may emerge.
Type II agency costs relate to situations in which self-motivated managers work with a single controlling
shareholder with a large ownership stake to potentially harm the interests of the smaller shareholders.
The literature on tunneling suggests that large shareholders may extract resources from the companies
they control on favorable terms (i.e., tunneling) which leave fewer resources available to the smaller
shareholders. Based on the greater availability of resources provided by tax avoidance, companies with
a large controlling shareholder and a propensity to engage in tunneling may be more likely to engage in
tax avoidance to make more resources available for tunneling.
Contrary to the Type II Agency cost ideas in the previous paragraph, Badertscher et al. (2013) suggest
that USA companies with a controlling shareholder engage in less tax avoidance, which they attribute
to more concentrated owners being more risk averse. The United States provides more protections for
minority shareholders than some other countries (e.g., Reese and Weisbach, 2002), which may explain
why Badertscher et al.’s (2013) results may not comport with the theory of Type II Agency costs.
However, these Type II agency conflicts exist in other places, especially among emerging countries (La
Porta et al., 1999). These conflicts are relatively unexplored in the literature. Studies in countries outside
the United States may be useful in understanding the interplay between large controlling shareholders
and tax avoidance, especially in context with less minority shareholder protection.
6.2 Tax Avoidance in Developing Countries

The existing tax avoidance literature considers a wide variety of factors related to the tax avoidance. In
general, the basic question in this literature is: what kinds of companies (and what type of managers)
avoid more tax than others. Some unexplored areas relate to institutional context in non-USA countries,
especially developing countries.
Using economy-wide data, Cobham and Janský (2018) find that revenue losses (which can result from
tax avoidance) are an especially acute problem in lower income countries (which may be least able to
afford the loss of government revenue). Bennedsen and Zeume (2017) find that firm value increases
when countries exchange tax information because tax haven jurisdictions can be used for expropriation
activities, and this possibility is reduced when countries share tax information. Both of these studies
suggest that the unique background of some countries may provide opportunities to further develop tax
avoidance research.
Also, while the USA Tax system is mainly income-tax driven, other countries may rely to a greater
extent on other forms of taxation, such as value-added taxes. Avoidance of these non-income taxes is a
relatively unexplored research area.
6.3 Social Responsibility Investors and Tax Avoidance

Paying taxes can be viewed as a form of socially responsible behavior by contributing to the advancement
of societal goals. Sikka (2010, p. 166) asserts: “the payment of taxes represents a litmus test of social
responsibility.” Firms not avoiding taxes (i.e., willingly paying their taxes) may be viewed more favorably
by socially-responsible investors. This notion suggests that the relationship between the interests and
managers and shareholders relative to tax avoidance can be complex. The issue of whether socially
responsible investors (e.g., mutual funds with a social-responsibility investment objective) are less likely
to invest in tax-avoiding firms is an area of potential for future research.
6.4 Tax Decision Makers within Firms

Hanlon and Heitzman (2010) pose the question: who makes the tax decisions for the firm? While there
is research suggesting that executive characteristics are related to corporate tax avoidance (e.g., Dyreng
et al., 2010), the black box of how tax choices are made within organizations is unknown. For example,
the black box could include the extent to which executives make tax avoidance decisions themselves or
establish a culture in which tax avoidance is encouraged or discouraged. As an example of how executive
can influence the tax avoidance culture of the organization, top executives may treat the tax department
as a profit center, which would encourage tax avoidance (Fortune, 2011). Acharya et al. (2011) suggests
that managers below the C-Suite level may manage their bosses to guard the long-term interest of the
organization. If this dynamic takes place, the organization may be less likely to engage in tax avoidance.
Understanding the internal dynamics of tax avoidance decisions may require a more in-depth case study,
or surveys among willing companies.
6.5 Measurement of Tax Avoidance

Most measures of corporate tax avoidance (e.g., BTD and ETR) are indirect and potentially noisy
measures of tax avoidance. The existing measures are based on data obtained from financial statements,
because tax returns are not publicly available. Chow et al. (2019) use a more direct measure of corporate
tax avoidance: disclosure of adjustments and penalties for underpayment of tax. This data arises from a
requirement among Chinese companies to disclose the resolution of such cases. Because the cases involve
underpayment of taxes, these disclosure can also more cleanly measure tax evasion (paying less tax than
the law demands), and not simply tax avoidance (paying less tax through legal means).
6.6 Tax Avoidance and Managerial Decision Making

Cash saved by tax avoidance could be used for productive corporate purposes (e.g., investing in projects
with a positive net present value, paying dividends, paying down high-interest debt) which could increase
firm value. Research could explore whether tax-avoiding companies use the extra cash to engage in more
productive endeavors, such as greater research and development.
Managers may not always make the best choices for allocating corporate resources (e.g., Jensen, 1986)
and the incremental resources available from tax avoidance could be used for sub-optimal purposes (e.g.,
Desai and Dharmapala, 2006). The possible effects of tax avoidance on managerial decision-making have
not been fully explored. For example, companies may overpay when acquiring other companies (e.g.,
Harford et al., 2012). If the company making the acquisition has extra cash available from tax avoidance,
they may be more likely to overpay for the acquisition. Gu and Lev (2011) suggest that such overpayment
can be identified through subsequent write-downs of goodwill arising from the acquisition.
6.7 Tax Avoidance and Other Stakeholders

Research on the consequences of tax avoidance generally focuses on the potential effects of tax avoidance
on the firm and its shareholders. Other stakeholders may also respond to tax avoidance behavior. For
example, individual customers may prefer to purchase products from companies that they perceive pay
their fair share in taxes, which can be viewed as socially responsible. Business customers may prefer to
partner with suppliers who engage in less risky corporate behavior, including less tax avoidance, to ensure
an uninterrupted supply of raw materials.
808 WANG ET AL.
Acknowledgements
The authors gratefully thank the constructive comments and suggestions from the editor Iris Claus and two
anonymous reviewers. We also appreciate funding support from the National Natural Science Foundation of
China (Grant No. 71972152).
Notes
1. Hanlon and Heitzman (2010) summarize 12 kinds of measures based on research in USA background,
i.e. GAPP effective tax rate, Book-tax difference (BTD), unrecognized tax benefits.
2. Christensen et al. (2015) use top executive’s personal political orientation as the proxy of conservatism,
and find that, in United States, firm with top executives who lean toward the Republican Party engage
in less tax avoidance than firms with top executives who lean toward the Democratic Party.
3. They examine the impact of three tax system characteristics — required book-tax conformity,
worldwide versus territorial approach, and perceived strength of enforcement, on tax avoidance.
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CORPORATE TAX AVOIDANCE: A LITERATURE REVIEW AND RESEARCH

Article in Journal of Economic Surveys · December 2019

Fangjun Wang Sun Junqin

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CORPORATE TAX AVOIDANCE: A LITERATURE

Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

How is aggressive of the activity?

Corporate tax avoidance

Legitimate tax avoidance Tax evasion

2. Motivations of Corporate Tax Avoidance

2.1 Financial Interest Motivation

Figure 2. The Research Framework of Corporate Tax Avoidance.

2.2 Social Responsibility Motivation

3. Measurement of Corporate Tax Avoidance

3.1 Effective Tax Rate

3.2 Book-Tax Differences

3.3 Measure Based on Disclosure of Tax Enforcement Actions

4. The Determinants of Corporate Tax Avoidance

4.1.1 Firm-Level Characteristics

4.1.2 Ownership Structure

Table 1. Internal Determinants of Corporate Tax Avoidance.

Determinants Main findings Papers

Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

4.1.3 Executives’ Personal Characteristics

4.1.4 Executive Compensation Plans

4.1.5 Internal Governance

4.2 External Determinants

4.2.1 Institutional Factors

4.2.2 External Markets

Table 2. External Determinants of Corporate Tax Avoidance.

Determinants Main Findings Papers

4.2.3 External Governance

4.2.4 Social Networks

5. The Consequences of Corporate Tax Avoidance

Table 3. Consequences of Corporate Tax Avoidance.

Consequences Main findings Papers

5.1 Corporate Value

5.2 Stock Market Reaction

5.3 Firm Risk

5.4 Accounting and Auditing Consequences

6. Future Research Opportunities

6.1 Type II Agency Costs

6.2 Tax Avoidance in Developing Countries

6.3 Social Responsibility Investors and Tax Avoidance

6.4 Tax Decision Makers within Firms

6.5 Measurement of Tax Avoidance

6.6 Tax Avoidance and Managerial Decision Making

6.7 Tax Avoidance and Other Stakeholders

Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

Journal of Economic Surveys (2020) Vol. 34, No. 4, pp. 793–811

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