The Effects of Environmental Protection Activities on Corporate Tax Avoidance in Japan

Abstract

This study examines the effects of environmental protection activities on corporate tax avoidance. Focusing on environmental responsibility, we show an association between actual outlay on environmental protection activities and tax avoidance, as measured by the effective tax rate (ETR). We also leverage environmental ratings in accordance with previous studies. Using tax-deductible costs for environmental protection activities enables us to more directly analyze their effects on the ETR compared with previous studies because the ETR is measured in monetary amounts. Moreover, we investigate how corporate governance influences this association because both environmental protection and tax avoidance activities are largely related to management decision-making. The results show that the ETR decreases for firms that spend more on environmental protection, whereas it has no relation to environmental ratings. These results, which use environmental protection costs, are completely different from those using environmental ratings. We show that the negative effects of environmental protection costs on corporate tax avoidance are moderated for firms with more outside directors. Additionally, the negative relationship between environmental protection costs and the ETR is found to become stronger for firms that have higher institutional ownership. These results, related to outside directors and institutional ownership, suggest that corporate governance mechanisms that regulate management behavior play a prominent role in the association between environmental protection costs and tax avoidance.

Keywords: Tax Avoidance, Environmental Protection Activity, Environmental Protection Cost, Environmental Rating, Outside Director, Institutional Ownership

JEL Classification: G30, G32, H26, M14, M48