The Complementarity Between Tax Avoidance and Manager Diversion: Evidence from Tax Haven Firms

57 Pages Posted: 27 Nov 2017 Last revised: 28 Dec 2017

See all articles by T. J. Atwood

T. J. Atwood

University of Arkansas - Department of Accounting

Christina Lewellen

North Carolina State University - Department of Accounting

Date Written: November 21, 2017

Abstract

We investigate whether tax avoidance and manager diversion are complementary when the costs of diversion are low by comparing dividend payouts, performance, and overinvestments of tax haven firms versus other multinational firms based in countries with weak and strong investor protections. Desai and Dharmapala (2006, 2009a, 2009b) and Desai et al. (2007) set forth a theory of tax avoidance within an agency framework (the D&D theory) based on the assumption that tax avoidance and manager diversion are complementary when the corporate governance system is “ineffective” (i.e., the manager’s expected costs of diversion are low). Studies developing the D&D theory provide indirect evidence consistent with the model’s predictions but do not directly test this complementarity assumption. Recent studies of U.S. firms find no complementarity or find evidence inconsistent with this complementarity. Tax haven firms are corporate groups whose parent firms are incorporated in tax haven countries that are not the countries where the groups’ headquarters or primary operations are located (i.e., their “base” countries). We argue that tax haven incorporation potentially lowers the costs of diversion for managers of firms based in countries with weak investor protections. Using a sample from 28 base countries, we provide evidence that manager diversion and tax avoidance are complementary for tax haven firms based in countries with weak investor protections but not for tax haven firms based in countries with strong investor protections. Our results are consistent with the complementarity assumption underlying the D&D model and provide additional insights into the potential impact of the decentralization of the global firm.

Keywords: Tax Avoidance, Tax Havens, Rent Extraction, Managerial Diversion, Corporate Governance

JEL Classification: M41, H20, H26

Suggested Citation

Atwood, T. J. and Lewellen, Christina, The Complementarity Between Tax Avoidance and Manager Diversion: Evidence from Tax Haven Firms (November 21, 2017). Contemporary Accounting Research, 2017, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3075454 or http://dx.doi.org/10.2139/ssrn.3075454

T. J. Atwood

University of Arkansas - Department of Accounting ( email )

Business Bldg. 454
Fayetteville, AR 72701
United States

Christina Lewellen (Contact Author)

North Carolina State University - Department of Accounting ( email )

Raleigh, NC 27695-8113
United States

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