Impact of corporate governance on tax avoidance

• Published date: 01 August 2024
• Author: Mahdi Salehi,Sahar Jabbari,Zeynab Nourbakhsh Hosseiny,Fatemeh Eslami Khargh
• Date: 01 August 2024
• DOI: http://doi.org/10.1002/pa.2929

RESEARCH ARTICLE

Impact of corporate governance on tax avoidance

Mahdi Salehi

1

| Sahar Jabbari

1

| Zeynab Nourbakhsh Hosseiny

2

|

Fatemeh Eslami Khargh

1

1

Department of Accounting, Economics and

Administrative Sciences, Ferdowsi University

of Mashhad, Mashhad, Iran

2

Accounting, Technical and Vocational

University (TVU), Tehran, Iran

Correspondence

Mahdi Salehi, Department of Accounting,

Economics and Administrative Sciences,

Ferdowsi University of Mashhad, Mashhad,

Iran.

Email: mehdi.salehi@um.ac.ir

In light of the pivotal role that taxes play as a primary source of income, particularly

within developing economies, this study aims to examine the influence of various

corporate governance (CG) mechanisms on tax avoidance. We employ three proxies

to measure tax avoidance or tax management within companies listed on the Tehran

Stock Exchange (TSE). The CG mechanisms under scrutiny encompass board size and

independence, CEO duality, auditor type, common stock ratio of at least 5% to total

stock, managers' common stock holdings about total stock, gender diversity, manager

ownership value, board meeting frequency, CEO stock ownership percentage, institu-

tional shareholders' stock holdings, audit committee membership, and financial spe-

cialization. This research investigates 192 companies listed on the TSE, utilizing data

available on the TSE website from 2011 to 2021. Our findings indicate that while

several CG mechanisms, such as board size and independence, audit firm size, gender

diversity, institutional ownership, and the specialization of audit committee members,

serve to reduce tax avoidance, CEO duality exacerbates it. Moreover, profitability,

financial leverage, and capital significantly inhibit tax avoidance. In contrast, the

return on assets (ROA), economic growth, and inflation have a pronounced positive

association with tax avoidance. A notable constraint of this study lies in its exclusive

focus on publicly listed firms, driven by the availability of relevant information. This

study offers valuable insights into the three dimensions of tax avoidance and their

interaction with CG mechanisms, with implications for performance monitoring.

KEYWORDS

corporate governance, tax avoidance, tax management

1|INTRODUCTION

Corporate governance (CG) serves as a safeguard for shareholders'

interests, with its multifaceted benefits encompassing the enhance-

ment of performance and the augmentation of shareholder wealth

(Saygili et al., 2021). Moreover, CG bolsters a company's transparency

and accountability to its investors, addressing their concerns (Ben

Abdallah & Bahloul, 2021; International Finance Corporation, 2020).

However, it is worth noting that CG models are not a one-size-fits-all

solution for every stakeholder across the global landscape of compa-

nies and stock markets (Tricker, 2015). This observation underscores

the imperative need for stock markets and nations to devise a robust

strategy to combat agency issues stemming from the conflicting inter-

ests between managers and shareholders (Kyere & Ausloos, 2021).

These agency issues may result in the company incurring agency costs

(Jensen & Meckling, 1976), negatively or positively impacting perfor-

mance (Afriyie et al., 2021). The concentration of power in the hands

of executive directors can alter the fundamental objective of the firm,

diverting it from the pursuit of sustained growth in shareholder

wealth. CEO duality, for instance, can compromise overall perfor-

mance (Naciti, 2019; Shahbaz et al., 2020). CG is pivotal in mitigating

the information asymmetry between majority and minority share-

holders (Aluchna & Kaminski, 2017). It aligns the interests of managers

and shareholders while curbing opportunistic behaviors arising from

Received: 29 November 2023 Revised: 16 April 2024 Accepted: 30 May 2024

DOI: 10.1002/pa.2929

J Public Affairs. 2024;24:e2929. wileyonlinelibrary.com/journal/pa © 2024 John Wiley & Sons Ltd. 1of16

https://doi.org/10.1002/pa.2929

conflicting interests (Chen et al., 2017). Furthermore, it designates the

audit committee as the guardian of shareholders' assets (Wasdani

et al., 2021). Nevertheless, the stewardship theory challenges the

notion of conflicted interests between managers and owners, assert-

ing that agents (managers) reliably safeguard shareholders' interests

(Donaldson & Davis, 1991; Velte, 2023). This perspective diminishes

CG structures and the need to monitor managerial practices. Within

the agency theory framework, asymmetric information is identified as

a source of agency issues (Liu, 2020), leading to suboptimal decisions

(Bergh et al., 2019). This information as ymmetry empowers opportu-

nistic managers to engag e in earnings management and tax reportin g

aggressiveness (TRA ), elevating compensa tion (Chen & Lin, 2017).

Since tax constitutes a significant operating expense that directly

influences a company' s financial position, CG emerges as an effec-

tive tool for monitori ng management. The pur suit of tax manage-

ment or avoidance becom es necessary for firms, particularly in

environments with high t axes imposed by governme nts, compelling

companies to explore leg al and, at times, illegal me thods to reduce

their tax burden (Rego & Wilson, 2012). No tably, Firmansyah et al .

(2022) have demonstrated the i nfluence of tax aggres siveness on

ownership structure an d the role of tax authorit ies in monitoring.

Their findings highligh t the significance of con trol blockholders in

influencing board char acteristics. Additio nally, Chen et al. (2010)

have shown that tax avoidance tends to be lower in family busi-

nesses. In essence, CG is a set of internal an d external control mech-

anisms that balance the int erests of shareholders an d managers. It

follows that when the rights of al l stakeholders are duly resp ected,

tax avoidance tends to dimin ish (Chyz et al., 2014). The primary

objective of this study is to investigate the connection between CG

and tax avoidance or manage ment.

Hence, the mechanisms of CG, as extensively explored in theoret-

ical literature and methodologies of numerous studies, encompass fac-

tors such as board size, board independence, CEO duality, auditor

type, the proportion of common shares representing at least 5% of

the total, the ratio of ordinary director shares to the total shares, gen-

der diversity, the monetary value of directors' ownership, board meet-

ing frequency, CEO share percentage, institutional shareholders' share

ownership, audit committee composition, and the financial expertise

of said committee. These factors collectively have the potential to

influence a company's extent of management activities and its inclina-

tion toward tax avoidance.

This research makes a notable contribution by consolidating

insights from various articles and studies, culminating in a comprehen-

sive summary of the pivotal variables in CG. Additionally, it introduces

three proxies for quantifying tax avoidance and scrutinizes the impact

of each governance indicator on tax avoidance. Doing so sets the

stage for future research that may consider integrating additional

social variables.

Taking a broader perspective, this study delves into the multiface-

ted landscape of CG, embracing a multitude of variables associated

with tax management and avoidance drawn from diverse research

sources. In light of this, regulatory bodies and oversight institutions

can adopt a more holistic approach, examining each component with

a comprehensive outlook and implementing measures to mitigate or

curtail tax avoidance activities.

The subsequent sections are organized as follows to provide a

glimpse of the article's structure: The second section delves into the

fundamentals and theoretical underpinnings of the research variables.

Following that, the third section elucidates the applied research pro-

cess and methodology. The fourth section unveils the findings, offer-

ing in-depth analyses, while the concluding section proffers

conclusions and recommendations.

2|THEORETICAL FOUNDATION

2.1 |Tax avoidance

Tax plays a pivotal role in shaping firm decisions, as it carries signifi-

cant implications for business costs and directly impacts profitability

and shareholders' value. Tax-related expenses often compel compa-

nies to explore various practices within the bounds of legality and

sometimes stray into illegal territory (Amri et al., 2023). Within legal

parameters, companies may exploit tax code gaps, navigate through

legal gray areas (Sánchez-Ballesta & Yagüe, 2023), or utilize legitimate

loopholes to curtail their tax liabilities (Hanlon & Heitzman, 2010).

These strategies are categorized under the umbrella of legal tax reduc-

tion, with tax avoidance serving as a prominent example, encompass-

ing practices such as tax aggressiveness and tax saving (commonly

referred to as tax sheltering) (Amri et al., 2023). It is worth noting that

while tax avoidance, as a part of tax planning, can enhance a com-

pany's cash flow, it also carries inherent risks. If taken to extremes, tax

avoidance can lead to detrimental consequences, including increased

agency costs, heightened information risk, and heightened scrutiny

from tax authorities, adversely affecting debt costs (Sánchez-

Ballesta & Yagüe, 2023). Moreover, tax avoidance is not without its

own set of costs, which include implementation, enforcement, politi-

cal, and tax planning expenses, along with the potential for negative

publicity. These costs must be weighed against the advantages of tax

avoidance. Importantly, it can diminish transparency in a company's

financial operations (Athira & Ramesh, 2023).

2.2 |Tax management

Tax management represents a strategic organizational process

wherein a company seeks to minimize its tax liabilities, harness tax

opportunities, and mitigate political costs (Hanlon & Slemrod, 2009).

Companies endeavor to optimize their tax value, provided that doing

so does not result in excessive expenses (Hanlon & Heitzman, 2010).

Taxes, while they serve as a source of income for governments, simul-

taneously translate into income reductions for corporations. Conse-

quently, corporations resort to earnings management to exert control

over their income. This tax management practice, while elevating a

company's net income and reducing tax outflows, is often more preva-

lent among companies with substantial institutional ownership. This

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