Managerial Ability and Tax Avoidance

Chang Youl KO1, Joonho PARK2, Hoon JUNG3

1 Department of Accounting, Hanyang University, 222 Wangsimni-ro, Seongong-gu, seoul 133 791, Republic of Korea, go2286@hanyang.ac.kr

2 Department of Accounting, Hanyang University, 222 Wangsimni-ro, Seongong-gu, seoul 133 791, Republic of Korea, bizintel@hanyang.ac.kr

3 Korea Information Society Development Institute, 36 Jang gun maeul 3 gil, Gwacheon-si, Gyeonggi-do, 427-710, Republic of Korea, guyhoon@empas.com

Abstract. This study examines the effects of managerial ability on tax avoidance. We find that there is a statistically meaningful negative relation between managerial ability and tax avoidance. This finding suggests that managerial ability influences firm’s tax avoidance behaviors.

Keywords: Managerial Ability, Tax Avoidance, Firm Value

1 Introduction

The attempt to maximize profit by reducing tax can be divided into three types; tax evasion, tax avoidance and tax saving (Kang 2012, Son et al. 2012). Tax evasion is the behavior which violates tax acts to conceal the fact that taxation requirements were met by fraud or misconduct. Tax evasion is violating the conduct of the law and tax crimes, corresponding to the elements of crime in the Punishment of Tax Evaders Act. Tax evasion induces substantial impairment of tax revenue. Tax saving is decreasing taxable income by legal methods of the tax act to reduce the tax burden by legal and reasonable methods. Active use of tax credits and tax reductions are included in tax saving. Tax avoidance is between tax evasion and tax saving. Tax avoidance is a legal and effective conduct in civil and common law, but consequently tax avoidance induces the evasion of tax payments. Tax avoidance means decreasing tax burden by contracts or transactions which are not economically reasonable, exploiting the negligence or lack of legislation.

There are traditional view and agency theory view about the relation between tax avoidance and firm value. Prior researches showed the mixed results about the relation between tax avoidance and firm value. Managers make a decision to maximize firm value ultimately. Managers who are in charge of the strategic decision and planning act to increase firm value consistently. Tax avoidance is a part of managerial decision. To investigate if there is the difference as the extent of managerial ability level is very important research subject. It helps to understand the difference of managerial decision. This study examines the effects of managerial ability on tax avoidance.

Advanced Science and Technology Letters Vol.34 (Business 2013), pp.1-4

http://dx.doi.org/10.14257/astl.2013.34.01

ISSN: 2287-1233 ASTL Copyright © 2013 SERSC

Managers can transfer resources which could be transferred to national tax authority to the firm through tax avoidance. Under the extended traditional view on tax avoidance, high ability managers can increase resources which belong to investors and could be transferred to national tax authority by the means of maximizing tax avoidance. In other words, high ability managers will increase shareholder value by maximizing tax avoidance.

With respect to tax avoidance, explicit costs, political costs, and the costs of defamation and various non-tax costs will occur. Therefore, shareholders do not always want to minimize corporate tax burden by the means of aggressive tax avoidance because there is the risk of tax imposing and legal punishment. On the other hand, managers want to increase tax avoidance because of short term profit incentive. If incentive compensation contract do not make interest alignment between shareholders and managers, managers are likely to do excessive tax avoidance strategy. This tax avoidance will decrease firm value. Under the extended agency theory view on tax avoidance, high ability managers maximize output of firm and do less tax avoidance strategy. Managerial ability means that the relative efficiency which maximizes output of firm compared to peer-firms in the same industry (Demerjian et al. 2012). In managing firm which has various resources, high ability managers will get max output by efficient resource using. Thus we predict that high ability managers will maintain firm value and performance compared to low ability managers in the same industry. When investors consider tax avoidance as a factor which decreases firm value, high ability managers recognize this and will make an effort to decrease the level of tax avoidance.

2 Empirical Model and Result

We use the OLS method to examine the relationship between tax avoidance and managerial ability. Our research design uses the OLS method with tax avoidance calculated by Desai and Dhamapala (2006) as the dependent variable and managerial ability calculated by Demerjian et al. (2012) as the independent variable.

ttttt NOLLEVROAMATAXAVOID 43210 βββββ ++++=

tttt MTBSIZEINTANPPE 8765 ββββ ++++

ηϕφβ ++++ ∑∑==

t

T

tt

K

kkkt YEARINDAGE

119

where TAXAVOID = tax avoidance calculated by Desai and Dhamapala (2006) MA = managerial ability calculated by Demerjian et al. (2012) ROA = operating income divided by total asset LEV = total debt divided by total asset NOL = an indicator variable that defined as: 1 if deficit carried over is less than 0 and 0 otherwise

Advanced Science and Technology Letters Vol.34 (Business 2013)

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PPE = property, plant and equipment divided by total asset INTAN = intangible asset divided by total asset SIZE = natural log of total assets MTB = market value divided by book value AGE = natural log of (listed years after IPO +1) ∑IND = industry dummies ∑YEAR = year dummies

If high ability managers maximize tax avoidance, managerial ablity is expected positive relationship with tax avoidance and β1 is positive (+). However high ability managers maximize firm value through not only tax burden but also output of firm by efficient resource using, high ability managers do less tax avoidance. Therefore managerial ablity is expected negative relationship with tax avoidance, β1 is negative (-). To control various factors that affect tax avoidance, we consider the well-documented determinants of tax avoidance in previous researches (Desai and Dhamapala 2006; Black et al. 2006; Koh et al. 2007; Son et al. 2012; Kang 2012).

Table presents the results for the relationship between managerial ability and tax avoidance. The coefficient of MA was negative and statistically significant. This result shows high ability managers maximize firm value through not only tax burden but also output of firm by efficient resource using and high ability managers do less tax avoidance.

Table Managerial Ability and Tax Avoidance

Variables1) coefficient Standard

errors t-value P>t confidence interval of 95%

MA -0.0264*** 0.0095 -2.78 0.01 -0.0450 -0.0078 ROA 0.2257*** 0.0126 17.90 0.00 0.2010 0.2504 LEV -0.0027 0.0041 -0.66 0.51 -0.0108 0.0053 NOL 0.0165*** 0.0043 3.83 0.00 0.0080 0.0249 PPE 0.0351*** 0.0067 5.21 0.00 0.0219 0.0483

INTAN 0.0119 0.0442 0.27 0.79 -0.0748 0.0986 SIZE 0.0005 0.0006 0.90 0.37 -0.0006 0.0017 MTB -0.0021* 0.0012 -1.79 0.07 -0.0045 0.0002 AGE 0.0006 0.0011 0.56 0.58 -0.0015 0.0027

Constant -0.0336*** 0.0122 -2.74 0.01 -0.0576 -0.0095 Industry dummies Included

Year dummies Included

N 2,941

R-squared 0.1223

*/**/***denote significance at the 10%, 5%, and 1% levels, respectively.

Advanced Science and Technology Letters Vol.34 (Business 2013)

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3 Conclusion

Tax avoidance is a part of such managerial decision makings. It can be a significant clue to see whether managerial ability has an influence on the tax avoidance level to assure that a corporate management style depends on managerial ability. This study performs an empirical analysis on the relation of managerial ability and tax avoidance level.

The result of analysis indicates that there is a statistically significant negative relationship between managerial ability and tax avoidance. The contribution of this research is that this study extends prior study (Dyreng et al., 2010) claiming that the tax avoidance level varies depending on the manager and proves the negative relation between the managerial ability and the tax avoidance.

References

1. Black, B., H. Jang, and W. Kim, 2006, “Does Corporate Governance Predict Firms' Market Values? Evidence from Korea”, The Journal of Law, Economics and Organization 22(2): 366-413.

2. Desai, M. and D. Dharmapala, 2006, “Corporate Tax Avoidance and High Powered Incentives”, Journal of Financial Economics 79: 145-179.

3. Demerjian, P., B. Lev, and S. McVay, 2012, “Quantifying managerial ability: A new measure and validity tests”, Management Science 58(7): 1229-1248.

4. Dyreng, S. D., M. Hanlon and E. L. Maydew, 2010,“The effects of executives on corporate tax avoidance”, The Accounting Review 85(4): 1163-1189.

5. Kang, Jeongyeon, 2012, “The Effects of Corporate Governance on the Association between Tax Avoidance and Firm Value”, Ph.D. dissertation, The Hanyang University.

6. Koh Yun Sung, Jee Hong Kim and Won-Wook Choi, 2007, “A Study on Corporate Tax Avoidance”, Korean Journal of Taxation Research 24(4): 9-40.

7. Son, Un-Seung, Sang Cheol Lee, Dong-Hoon Yang, and Kap Soon Kim, 2012, “Moderating Effect of Executive Stock Option on the Relationship between Tax Sheltering and Firm Value”, Korean Journal of Management Accounting Research 12(1): 23-61.

Advanced Science and Technology Letters Vol.34 (Business 2013)

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