HOW DOES CULTURAL TIGHTNESS-LOOSENESS INFLUENCE CORPORATE TAX AVOIDANCE?

Abstract

This study investigates whether cultural tightness-looseness — the strength of social norms and the degree of homogeneity in values and beliefs — influences tax avoidance activities of publicly traded firms in the United States. I find that firms in tight cultures exhibit lower levels of tax avoidance compared to those in loose cultures. The effect is economically significant. For example, moving from the loosest culture to the tightest culture results in a 1.47% increase in cash effective tax rates, which is equivalent to an increase in cash tax expense of 4.12 million dollars for an average firm. Consistent with the argument that tight cultures lead to similar values and behavior, I further find that firms' effective tax rates (or book-to-tax differences) are less likely to deviate from those of their peer firms in the presence of tight cultures. This study also shows that tight cultures affect how firms respond to Accounting Standards Codification (ASC) 740-10, which requires public companies to disclose their uncertain tax benefits — a contingent tax liability reflecting additional tax payments that a firm has to pay if audited by the Internal Revenue Service. I find that firms associated with tight cultures are more likely to reduce the uncertain tax benefit after ASC 740-10. This study contributes significantly to the literature on informal institutional determinants of tax avoidance. It also contributes significantly to the emerging literature on peer effects by suggesting that homogenous beliefs, resulting from cultural tightness, can help explain common components in tax avoidance.