Tax avoidance, value creation and CSR – a European perspective

• DOI: https://doi.org/10.1108/CG-08-2016-0166
• Pages: 803-821
• Date: 02 October 2017
• Published date: 02 October 2017
• Author: Dirk Kiesewetter,Johannes Manthey
• Subject Matter: Strategy,Corporate governance

Tax avoidance, value creation and

CSR – a European perspective

Dirk Kiesewetter and Johannes Manthey

Dirk Kiesewetter and

Johannes Manthey both

based at the Department

of Business Taxation,

Julius-Maximilians-

Universitat Wurzburg,

Wurzburg, Germany.

Abstract

Purpose –This paper aims to answer how corporate governance and corporate social responsibility

(“CSR”) affect the relationship between value creation and tax avoidance. This study further analyses

the impact of the institutional environment, i.e. whether a country is rather a liberal or a coordinated

market economy, on the relationship between CSR and tax avoidance.

Design/methodology/approach –The empirical analysis comprises a panel data set of 7,924

observations for the years from 2005 to 2014 for European companies. The relationship between value

creation and tax avoidance is tested by grouping the sample in high and low CSR performers. Similarly,

the impact of the type of market economy is analysed for the firms.

Findings –The research design does not find evidence that tax avoidance is creating value. The

empirical findings reveal that there is a positive relationship between value creation and the effective tax

rate for firms with low social and environmental characteristics. Further, this analysis could show that

stronger corporate governance is associated with a lower effective tax rate in both coordinated and

liberal market economies. The analysis identifies social strengths being associated with a higher

effective tax rate for coordinated market economies.

Practical implications –It is proposed to encourage CSR disclosure. The creation of incentives for

social strengths could increase tax revenue. Firms should reconsider whether the engagement in tax

avoidance is worth it and pursue social responsibility to achieve higher value creation for their

stakeholders.

Originality/value –The paper challenges the intuitive expectation that tax avoidance creates value. It

is suggested that the governance and CSR culture, as well as the tax legislation in Europe, is different

to the USA. Conclusively, tax avoidance is not generating value for the European sample.

Keywords CSR, Corporate governance, Agency costs, Tax, Value creation, Tax avoidance

Paper type Research paper

1. Introduction

The relationship between tax avoidance and corporate governance, as well as corporate social

responsibility (CSR), is analysed in a variety of papers conducting research on samples of

Anglo-Saxon countries, in particular the USA. There is little empirical evidence of the relation for

European companies. The aim of this paper is to understand the influence of corporate

governance and CSR on tax avoidance for European companies. Further, the analysis attempts

to clarify whether value is created by the engagement in tax avoidance. This paper picks up the

findings of the tax avoidance literature on corporate governance, and subsequently extends

the scope to CSR. The study aims to challenge the proposition that the agency framework

largely used as an explanation of tax avoidance can be transferred to European companies.

There are differences in the corporate governance cultures between Europe and the USA

(Shleifer and Vishny, 1997). These differences put the transferability of the agency concept to

European companies into question.

Recent papers established the relationship of corporate governance and tax avoidance

and propose that tax avoidance reduces the tax burden for firms with superior corporate

governance. The literature on corporate governance finds that tax management is

JEL classification – H20, H25,

H26, M41, M48

Received 11 August 2016

Revised 31 May 2017

Accepted 4 July 2017

The authors are grateful for

helpful comments by Martin

Fochmann (Universitaet zu

Koeln, Cologne), Jochen

Hundsdoerfer (Freie

Universitaet, Berlin),

Rainer Niemann

(Karl-Franzens-Universitaet,

Graz) and other participants

received at the Arqus

conference in Munich 2016. We

also thank the comments by

Sven Hoerner and Jacob

Justus Leidner, both from the

University of Wuerzburg. The

funding provided by the

University of Wuerzburg is

gratefully acknowledged.

DOI 10.1108/CG-08-2016-0166 VOL. 17 NO. 5 2017, pp. 803-821, © Emerald Publishing Limited, ISSN 1472-0701 CORPORATE GOVERNANCE PAGE 803

associated with agency costs and reporting costs (Desai and Dharmapala, 2006). There is

evidence that corporate governance is a major determinant of value creation and

destruction (Desai and Dharmapala, 2009). The literature on CSR leads to the conclusion

that there is a positive relationship between CSR and tax avoidance (Lanis and Richardson,

2012). The finding that higher CSR is associated with a lower effective tax rate was

confirmed by other studies in the subsequent years (Davis et al., 2016). These findings

support the view that companies are pointing at their social responsibility on the one hand,

but on the other hand, engage in tax avoidance strategies (Sikka, 2010). There appear to

be complex relations and conditions whether tax avoidance strategies generate value.

This paper distinguishes itself from other studies by investigating the relationship between

tax avoidance and value creation by grouping a sample of European companies in high

and low CSR performers. Subsequently, the determinants of CSR and tax avoidance are

examined by grouping the sample based on whether a country is a liberal or a coordinated

market economy, as suggested by Jackson and Apostolakou (2010). Thereby, the

influence of the countries’ institutional characteristics is analysed. To the best knowledge,

no paper analysed the influence of tax avoidance and value creation with respect to CSR

and the type of economy. The analysis extends the existing research developed in the USA

to European companies and questions whether the agency framework, as an explanation

for tax avoidance, can be applied to European companies.

The sample for the empirical analysis comprises 7,924 observations for European

companies from 20 countries. In summary, the analysis shows that tax avoidance is not

creating value. Throughout, the coefficients indicate a positive association. The relation

between the effective tax rate and value creation is positive and highly significant for the

low levels of environmental and social performance. Corporate governance cannot explain

whether tax avoidance creates value for European companies. The study finds that the

agency concept does not serve as a good explanation of tax avoidance for the European

sample. However, CSR does have an influence on the tax avoidance behaviour. Firms with

weak social and environmental characteristics showed a higher effective tax rate. Further,

there was no evidence found for value creation by the engagement in tax avoidance. The

analysis reveals that a higher effective tax rate is associated with higher value creation. The

agency theory based argumentation by Desai and Dharmapala (2009), suggesting that

strong governance can mitigate agency costs associated with tax avoidance, could not be

confirmed for the European sample. Neither do the findings confirm the “corporate

hypocrisy” argument by Sikka (2010).

Furthermore, the analysis could show that the corporate governance score has

significant explanatory power of the effective tax rate. The relation is negative for both

the coordinated and liberal market economies. The effect is stronger for firms in liberal

market economies. This may result from differences in the corporate governance

circumstances of companies in the two types of economies. The social score is

positively associated with the effective tax rate only for the coordinated market

economies. Possibly, the social score plays a stronger role and mirrors the internal

affairs which extend to tax management as well.

This paper concludes that firms should reconsider their tax management activities. There

is no evidence that tax avoidance creates value. The “success” of tax avoidance does not

depend on corporate governance and CSR either. The agency concept, suggesting that

tax avoidance is creating value for firms with superior corporate governance, could not be

confirmed for the European sample. Within Europe, the type of economy has an influence

on the corporate governance culture and also on the effective tax rate. This study could not

explain why firms engage in tax avoidance even though it is not creating value for the

European companies. This research attempts to clarify whether the European tax system is

“tax avoidance proof” or the costs of tax avoidance outweigh the benefits.

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