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Do Constituency Statutes Deter Tax Avoidance?

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Title:Do Constituency Statutes Deter Tax Avoidance?
Authors:Kaishu Wu
Jonathan Ye
Keywords:Tax avoidance
Constituency statutes
Corporate social responsibility
Date Issued:31 Aug 2019
Abstract:The constituency statutes, passed mainly in the U.S. in the last century, allow firm directors to consider the interests of stakeholders other than shareholders (i.e., non-financial stakeholders) when making business decisions. One type of critical decisions managers make pertains to corporate tax planning, which creates value for the shareholders at the expense of the public interest or social welfare. In this paper, we investigate whether this law change with a permissive nature affects directors, and hence, managers' attitude towards corporate tax avoidance. Employing a staggered difference-in-difference method, we find that firms incorporated in the states that have adopted constituency statutes exhibit significantly higher ETRs based on current tax expense, but not total tax expense or cash tax paid. This causal relationship suggests that managers, with the permission to consider the social impact of tax avoidance, become less aggressive in tax planning. We further find that the effect of adoption is stronger for financially unconstrained firms and firms in retail businesses, where the demand (cost) for tax avoidance is lower (higher). Finally, we show that our main results are driven by firms located in states with a high sense of social responsibility and the firms with high levels of tax avoidance prior to the adoption. Overall, the findings in this paper suggest a positive social impact brought by the passage of constituency legislations.
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