Manager-Shareholder Alignment, Shareholder Dividend Tax Policy, and Corporate Tax Avoidance
Editor's Note: The following post comes to us from Dan Amiram of the Accounting Division at Columbia University, Andrew Bauer of the Department of Accountancy at the University of Illinois at Urbana-Champaign, and Mary Margaret Frank of the Darden School of Business at the University of Virginia.
In our paper, Manager-Shareholder Alignment, Shareholder Dividend Tax Policy, and Corporate Tax Avoidance, which was recently made publicly available on SSRN, we move away from equity compensation as a measure of manager-shareholder alignment and exploit a unique setting exogenous to the firm to assess the effect of manager-shareholder alignment on corporate tax avoidance. Our setting capitalizes on variation in the value to shareholders from corporate tax avoidance, which is driven by a country’s shareholder dividend tax policy. Firms in the United States, such as the ones examined in the prior literature, are subject to a classical tax system. Corporate earnings are taxed at the firm level and then again at the shareholder level when they are distributed as a dividend (i.e., double taxation). Therefore, corporate tax avoidance increases after-tax cash flows creating either more private benefits for managers or higher after-tax cash flows to shareholders. Other countries around the world employ an imputation tax system. In contrast to a classical system, an imputation system imposes taxes on corporate earnings at the firm level, but these corporate taxes paid are credited against the shareholders’ taxes when earnings are distributed as dividends. This credit causes the total tax paid on earnings to be equal to the shareholders’ tax (i.e., single taxation), so corporate tax avoidance increases after-tax cash flows available for managers’ private benefits but does not increase the after-tax cash flows to shareholders. Because corporate tax avoidance is costly, it actually reduces the after-tax cash flows to shareholders under an imputation system and makes them worse off.