Public Pressure and Corporate Tax Behavior

• Author: JARON H. WILDE,SCOTT D. DYRENG,JEFFREY L. HOOPES
• DOI: http://doi.org/10.1111/1475-679X.12101
• Published date: 01 March 2016
• Date: 01 March 2016

DOI: 10.1111/1475-679X.12101

Journal of Accounting Research

Vol. 54 No. 1 March 2016

Printed in U.S.A.

Public Pressure and Corporate

Tax Behavior

SCOTT D. DYRENG,

∗JEFFREY L. HOOPES,

†

AND JARON H. WILDE

‡

Received 30 July 2014; accepted 30 September 2015

ABSTRACT

We use a shock to the public scrutiny of firm subsidiary locations to investi-

gate whether that scrutiny leads to changes in firms’ disclosure and corporate

tax avoidance behavior. ActionAid International, a nonprofit activist group,

levied public pressure on noncompliant U.K. firms in the FTSE 100 to com-

ply with a rule requiring U.K. firms to disclose the location of all of their

subsidiaries. We use this setting to examine whether the public pressure led

scrutinized firms to increase their subsidiary disclosure, decrease tax avoid-

ance, and reduce the use of subsidiaries in tax haven countries compared to

∗Fuqua School of Business, Duke University; †Fisher College of Business, Ohio State Uni-

versity; ‡Tippie College of Business, University of Iowa.

Accepted by Christian Leuz. We thank Martin Hearson and Chris Jordan of ActionAid

International for extensive help understanding ActionAid’s investigation of the FTSE 100

firms, and for providing us with data used in this paper. We thank PwC, U.K. for help-

ing us with technical details of the U.K. tax system. We thank John Campbell, Travis Chow

(discussant), Dane Christensen, Cristi Gleason, Michelle Hanlon, Jim Hines (discussant),

Ken Merkley, Aaron Nelson, Tom Omer, Ed Outslay (discussant), Jeff Pittman, Steven Savoy,

Lisa De Simone, Jake Thornock, Connie Weaver, and Ryan Wilson for comments on a pre-

vious draft of this paper. We also thank workshop participants at the University of Iowa,

Vienna University of Economics and Business, the 2014 Midwest Accounting Research Con-

ference at Ohio State University, the University of Michigan 2014 MTAXI Conference, the

2014 Taxation in a Global Economy Research Symposium, and the University of Oxford

2014 Summer Tax Symposium. We also appreciate financial support from the Center for In-

ternational Business Education & Research at Ohio State University. This paper previously

circulated under the title, “Real Costs of Subsidiary Disclosure: Evidence from Corporate

Tax Behavior.” An Online Appendix to this paper can be downloaded at http://research.

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

147

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

148 S.D.DYRENG,J.L.HOOPES,AND J.H.WILDE

other firms in the FTSE 100 not affected by the public pressure. The evidence

suggests that the public scrutiny sufficiently changed the costs and benefits

of tax avoidance such that tax expense increased for scrutinized firms. The

results suggest that public pressure from outside activist groups can exert a

significant influence on the behavior of large, publicly traded firms. Our find-

ings extend prior research that has had little success documenting an empir-

ical relation between public scrutiny of tax avoidance and firm behavior.

JEL codes: H25; H26; H20; G39

Keywords: Real effects of disclosure; corporate taxation; corporate reputa-

tion

1. Introduction

Research examining the determinants and consequences of tax avoidance

in publicly traded firms has grown dramatically in the past decade (Hanlon

and Heitzman [2010]). Despite the substantial research on tax avoidance,

little is known about how firms respond to public scrutiny of their corporate

tax avoidance behavior. Decision makers within the firm potentially view

public scrutiny of tax avoidance activities negatively because of fears that

the public pressure could result in backlash against the firm or its products

from investors, politicians, and customers (Ernst & Young [2014], Graham

et al. [2014]), particularly if the firm is a government contractor or oth-

erwise indirectly supported by government programs. On the other hand,

decision makers potentially view public scrutiny of tax avoidance positively

as it could signal to investors that fewer of the firm’s resources will be lost

to the government because the firm has strategically arranged its affairs to

reduce tax payments. Moreover, if the firm is compliant with tax rules and

regulations, the risks associated with tax avoidance could be small (Dyreng,

Hanlon, and Maydew [2014]). On net, firms are likely to trade off the ben-

efits of tax avoidance with the political, reputational, and proprietary costs

that arise with increased public scrutiny.1In this study, we use a shock to

the public scrutiny of firm subsidiary locations to investigate whether that

scrutiny leads to changes in firms’ corporate tax avoidance activities.

Disclosure of the location and identity of specific subsidiaries can re-

veal information about corporate tax behavior given the significant oper-

ating implications and tax consequences associated with the jurisdictions

in which firms locate their operations (Dyreng and Lindsey [2009], Creal

1The recent “inversion wave” in the United States is an example of firms making a tradeoff

between lower tax bills and increased public scrutiny, especially by politicians. See, for

example, two letters written by Senator Dick Durban to AbbVie and Walgreens, available at

http://www.sdurbin.enate.gov/newsroom/press-releases/durbin-appalled-by-taxpayer-subsi-

dized-abbvies-decision-to-renounce-its-american-citizenship and http://www.durbin.senate.

gov/newsroom/press-releases/durbin-to-walgreens-renouncing-your-american-corporate-

citizenship-hard-to-defe-

nd, respectively.

PUBLIC PRESSURE AND CORPORATE TAX BEHAVIOR 149

et al. [2014]). In particular, subsidiary disclosure is important because it

provides external parties with information about firms’ use of tax havens

and geographic exposure.

In contrast to U.S. regulations that only require disclosure of significant

subsidiaries, the United Kingdom’s Companies Act of 2006 (“Companies

Act”) requires firms to disclose the name and location of all subsidiaries,

regardless of size or materiality. Although the U.K. law went into effect

in 2006, ActionAid International, a global nonprofit dedicated to ending

poverty worldwide, discovered in 2010 that approximately half of the firms

in the FTSE 100 were not disclosing the name and location of all sub-

sidiaries.2ActionAid’s finding was prima facie evidence that the Companies

House, the U.K. body charged with making required disclosures available to

the public, was not enforcing the subsidiaries disclosure requirement. More

importantly, the fact that some firms chose not to comply with the law sug-

gests that the cost of disclosing detailed information on subsidiaries (e.g.,

political costs, proprietary costs, and administrative burdens) was greater

than the benefit of a more complete information environment for the

noncompliant firms.3Stemming from noncompliant firms’ revealed pref-

erences toward nondisclosure, we assume that noncompliant firms have

higher costs of disclosing tax avoidance compared to the firms that com-

plied with the disclosure law.

The ActionAid discovery was part of an attempt to publicly shame FTSE

100 firms for having subsidiaries located in tax haven countries in an effort

to increase these firms’ willingness to pay taxes.4ActionAid’s shaming cam-

paign encompassed two stages: (1) pressuring FTSE 100 firms to become

compliant with U.K. law requiring firms to disclose the name and location

of each of their subsidiaries, and (2) broadly publicizing all of FTSE 100

firms’ lists of subsidiaries to highlight tax haven use. In the initial stage,

beginning in 2010, ActionAid directly pressured individual firms to com-

ply with the law. This pressure involved threatening the possibility of neg-

ative publicity for noncompliance with the disclosure rules and reminding

firms of ActionAid’s previous success in garnering negative media attention

2The FTSE are the 100 largest market cap firms trading on the London Stock Exchange.

These 100 firms represent over 75% of total market cap traded on the London Stock

Exchange.

3While the subsidiary disclosure portion of the Company Act of 2006 was unenforced, the

Companies Act of 2006 did provide for explicit monetary fines for noncompliance. However,

these fines, set at a maximum of £1,000 for initial noncompliance (for the company and

each officer in default), would have been inconsequential for the FTSE 100 firms we examine

(Companies Act of 2006, Section 410 (4) and 410 (5)).

4ActionAid did not attempt to differentiate between subsidiaries located in nations for non-

tax reasons and those used for tax avoidance purposes. For example, it is plausible that a U.K.

firm could have a subsidiary in Ireland, a country labeled as a tax haven, for a variety of nontax

reasons ranging from supply chain efficiencies to lower operating costs.