Does Social Capital Matter in Corporate Decisions? Evidence from Corporate Tax Avoidance

• Date: 01 June 2017
• Published date: 01 June 2017
• DOI: http://doi.org/10.1111/1475-679X.12159

DOI: 10.1111/1475-679X.12159

Journal of Accounting Research

Vol. 55 No. 3 June 2017

Printed in U.S.A.

Does Social Capital Matter

in Corporate Decisions? Evidence

from Corporate Tax Avoidance

IFTEKHAR HASAN,

∗CHUN-KEUNG (STAN) HOI,

†QIANG WU,

‡

AND HAO ZHANG

†

Received 21 November 2014; accepted 14 October 2016

ABSTRACT

We investigate whether the levels of social capital in U.S. counties, as cap-

tured by strength of civic norms and density of social networks in the coun-

ties, are systematically related to tax avoidance activities of corporations with

headquarters located in the counties. We find strong negative associations be-

tween social capital and corporate tax avoidance, as captured by effective tax

rates and book-tax differences. These results are incremental to the effects of

local religiosity and firm culture toward socially irresponsible activities. They

are robust to using organ donation as an alternative social capital proxy and

fixed effect regressions. They extend to aggressive tax avoidance practices.

Additionally, we provide corroborating evidence using firms with headquar-

ters relocation that changes the exposure to social capital. We conclude that

∗Gabelli School of Business, Fordham University, and Bank of Finland; †Saunders Col-

lege of Business, Rochester Institute of Technology;‡Lally School of Management, Rensselaer

Polytechnic Institute.

Accepted by Christian Leuz. We thank the editor and an anonymous referee for insightful

comments. The authors are grateful for helpful comments from participants of research work-

shops at Rochester Institute of Technology, Fordham University, University of Cincinnati, Uni-

versity of Nebraska, University of St. Andrews, Rensselaer Polytechnic Institute, and the U.S.

Securities and Exchange Commission. We thank Patrick Scanlon for editorial help. Hoi and

Zhang thank the Saunders College of Business at RIT for research support through summer

awards and Zutes Faculty Fellowships. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

629

Copyright C, University of Chicago on behalf of the Accounting Research Center,2016

630 I.HASAN,C.-K.HOI,Q.WU,AND H.ZHANG

social capital surrounding corporate headquarters provides environmental

influences constraining corporate tax avoidance.

JEL codes: A13; H26; M40; M41; Z13

Keywords: tax avoidance; tax aggressiveness; social capital; social norm; so-

cial network

1. Introduction

Social capital has been a subject of extensive research in sociology

(Coleman [1988]), political science (Putnam [1993]), and economics

(Fukuyama [1995], Woolcock [1998]). A central theme that emerges from

these studies is that social capital—vis-`

a-vis shared common beliefs (i.e., so-

cial norms) and dense associational networks—facilitates norm-consistent

behaviors and constrains norm-deviant behaviors. There is considerable ev-

idence showing that a community’s social capital affects the social and eco-

nomic behaviors of its residents (e.g., Putnam [2001], Guiso, Sapienza, and

Zingales [2004], Buonanno, Montolio, and Vanin [2009]). However, there

is little evidence relating a community’s social capital to decisions of local

corporations headquartered in the community.

In this study, we examine whether social capital at the county level in

the United States is systematically related to tax avoidance practices of lo-

cal corporations headquartered in the county. We operationalize the so-

cial capital construct using density of social networks and strength of civic

norms in U.S. counties in which firms’ headquarters are located, where

civic norms are nonreligious social norms that emphasize civic duty and so-

cially cooperative behaviors (Knack [1992], Guiso, Sapienza, and Zingales

[2010]).

On one hand, one would expect to observe a negative relation be-

tween social capital and corporate tax avoidance for the following rea-

sons. First, social environments affect individual belief and behavior con-

cerning the appropriateness of paying taxes (Alm and Torgler [2006],

Cummings et al. [2009]). Second, managers affect corporate decisions

(Bertrand and Schoar [2003]) and managers are susceptible to the influ-

ences of social peers surrounding corporate headquarters, such as neigh-

bors, social club members, and parishioners (e.g., Hilary and Hui [2009],

McGuire, Omer, and Sharp [2012]). Third, there is a widely shared so-

cietal belief that all citizens, including corporations, have a civic duty to

pay taxes.1These arguments imply that social peers in high-social-capital

1In every annual Taxpayer Attitude Survey in the past decade the Internal Revenue Service

(IRS) commissioned, the results consistently show that more than 90% of those taxpayers sur-

veyed either completely or mostly agree that “it is every American’s civic duty to pay his or her

fair share of taxes” (IRS [2013]). These societal expectations are echoed around the globe in

similar surveys conducted in Ireland, New Zealand, and the United Kingdom (Cleary [2013],

Christian Aid [2013]) and they are shared by people in all walks of life, including politicians

SOCIAL CAPITAL AND CORPORATE TAX AVOIDANCE 631

communities are more likely to perceive corporate tax avoidance behaviors

as norm-deviant since these practices are incongruent with the prescribed

values and standards associated with civic norms. Accordingly, managers

of corporations headquartered in high-social-capital communities should

anticipate higher psychic costs (Erard and Feinstein [1994]) and higher

social sanctions (Coleman [1988]) associated with corporate tax avoid-

ance decisions when compared to managers from corporations headquar-

tered in low-social-capital communities, leading these managers to refrain

from corporate tax avoidance practices and behave in a way that conforms

to the expectations of their social peers in the communities (Kohlberg

[1984]).

On the other hand, there is evidence that some constituents in the cor-

porate sector, including shareholders, directors, and executives, hereafter

corporate peers, are “tax-minded” in that they view tax minimization prac-

tices as acceptable means of conducting business operations and seek to

actively implement strategies reducing a firm’s tax burden.2Just as social

peers could influence managers, so could tax-minded corporate peers. As

such, managers could be influenced by two conflicting norms when making

corporate tax decisions: civic norms arising from social peers surrounding

corporate headquarters and tax-mindedness arising from tax-minded cor-

porate peers. If the influences of tax-minded corporate peers are particu-

larly overpowering in the corporate sector, one would expect the influences

of social peers on corporate tax decisions to be minimal and insignificant.

In this case, the levels of social capital surrounding corporate headquarters

and academicians. For instance, Paul Krugman describes companies engaging in corporate

inversion as “corporate deserters” that are “shirking their civic duty” (Krugman [2014]). Real-

izing the prevalence of these societal expectations, KPMG warned its corporate clients in 2013

that “now tax and the issue of paying your fair share is one of the most prominent areas be-

ing scrutinized by governments, the general public and, to a great extent, the media” (KPMG

[2013]). Because civic duty to pay taxes is a prevalent societal expectation and civic norms

emphasize civic duty and socially cooperative behaviors, there is a natural linkage between tax

avoidance and social capital, vis-`

a-vis civic norms.

2For instance, Rego and Wilson [2012] find that firms use equity risk incentives to mo-

tivate managers to undertake tax avoidance practices. Survey results reveal that managers

and directors “believe that current corporate law requires them to pursue legal courses

of action that maximize shareholder value” (Rose [2007, p. 319]). General Electric in

its 2010 Citizenship Report contends that “like any business or individual, we do like to

keep our tax rate low .. . we have a responsibility to our shareowners to reduce our

tax costs as the law allows” (http://link.springer.com/article/10.1007/s10551-006-9209-z).

While these aforementioned findings suggest that some corporate peers are tax-minded,

there is also evidence that some corporate peers hold an alternative view on the mat-

ter. The Disney Citizenship 2014 Performance Summary provides a succinct argument re-

flecting this alternative view: “We manage our tax affairs responsibly and carefully . .. we

also give due consideration to our reputation, brand, corporate, and social responsibili-

ties when assessing tax initiatives and uncertain tax positions, as well as the applicable le-

gal and fiduciary duties of directors and employees. Ultimately, we strive to manage all

taxes so as to provide a responsible outcome that considers the interests of all stakeholders”

(https://ditm-twdc-us.storage.googleapis.com/FY14-Performance-Summary.pdf).