The following article from the fall 2014 issue of Changing Business, the research magazine of the Johns Hopkins Carey Business School, looks at a study by Assistant Professor Xian Sun, in which she writes that the political beliefs of corporate CEOs strongly influence the tax-avoidance strategies of the firms they run.
The political beliefs of corporate CEOs strongly influence the tax-avoidance strategies of the firms they run, and firms led by both Republican-leaning and Democratic-leaning CEOs are associated with significantly more tax avoidance than companies with CEOs of no obvious political preference, according to a study by a Johns Hopkins Carey Business School assistant professor and three colleagues.
Researchers Xian Sun of the Carey School, Bill B. Francis and Qiang Wu of Rensselaer Polytechnic Institute, and Iftekhar Hasan of Fordham University assert in their working paper, “CEO Political Affiliation and Firms’ Tax Avoidance,” that Republican CEOs are associated with significantly more tax avoidance even when their equity-based incentives are low, suggesting that political ideology drives these CEOs’ tax decisions. In contrast, Democratic CEOs are associated with higher levels of tax avoidance under certain circumstances but only when their equity-based incentives are high.
Moreover, a company’s tax avoidance tends to increase when a Republican occupies the Oval Office, Sun and her colleagues found.
The researchers say their study, covering data from 1992 to 2007, is among the first to provide empirical evidence that the political beliefs of individual executives have a marked effect on their attitudes toward corporate tax avoidance. The existing research literature has shown that individual CEOs play a major role in setting their firms’ tax policy, though no previous study in this area has identified factors that explain this phenomenon.
“It’s an issue of broad economic impact because the savings being realized by these big, asset-heavy companies, while allowed by current tax law, can be viewed as revenue that isn’t realized by the government for public benefit,” says Sun. (She emphasizes that the term “tax avoidance” refers to legal methods of reducing tax payments, in contrast to the illegal actions associated with the phrase “tax evasion.”)
“Tax avoidance was most prevalent at firms run by Republican CEOs, but we saw that firms with Democratic CEOs also looked for ways to cut their taxes, if not on the same scale,” Sun says. “The firms with Republican CEOs used avoidance measures that ranged from aggressive to less aggressive, including measures that involved long-term tax avoidance. At the companies with Democratic CEOs, the avoidance methods generally involved book-to-tax difference and shelter activities. These are aggressive measures but don’t figure in a firm’s overall level of tax avoidance or in its long-term avoidance strategy.”
As Sun notes, these findings indicate that CEOs’ political preferences may indeed carry implications for corporate policies and therefore should be examined more carefully by researchers and others.
Sun and her colleagues additionally discovered that the influence of individual CEOs’ political views on tax-avoidance policies existed almost entirely at “poorly governed” firms – that is, where the top person is firmly entrenched, serving as both chief executive and chairman, with a non-independent board that holds little power.
A notable distinction of the Democratic CEOs, Sun says, is that their tax decisions are clearly associated with economic incentives. “For the Democratic executives, their tax-avoidance policies are explained less by their political views than by their desire to increase their own compensation by improving the company’s bottom line and the performance of its stock,” says Sun. “If there is high potential for compensatory reward, they will take more risks and avoid more taxes.”
What would constitute aggressive and risky forms of avoidance? According to Sun, they would include tax shelters and other tools that apparently are legal but might be more likely to trigger Internal Revenue Service scrutiny because of their complexity.
To determine the CEOs’ political sympathies, the researchers combed through a Federal Election Commission data base for donations made by chief executives at the 1,500 largest public firms across some 50 industries in the United States. Of the CEOs who made political donations to the two major parties during the 15-year sampling period, about 60 percent gave to Republicans.
In general, the executives made relatively small contributions – an average of 0.03 percent of their annual compensation – to one party or the other, rarely to both. About 200 of the CEOs switched party allegiance during the sampling period, as indicated by their political donations. Among those who switched to the GOP, their firms subsequently increased their total tax avoidance, while reduced avoidance was seen at firms where the CEOs switched to the non-Republican side (Democratic or no party preference).
Sun presented the paper in October 2013 at the annual meeting of the Financial Management Association, held in Chicago. The FMA is an international, 3,000-member organization of academicians and practitioners that promotes the development and dissemination of knowledge about financial decision making.