The impact of stakeholder orientation on tax avoidance: Evidence from a natural experiment

• Published date: 01 April 2023
• Author: Gary Chen,Ani Manakyan Mathers,Bin Wang,Xiaohong (Sara) Wang
• Date: 01 April 2023
• DOI: http://doi.org/10.1002/jcaf.22594

Received:  August Revised:  September  Accepted:  September 

DOI: ./jcaf.

RESEARCH ARTICLE

The impact of stakeholder orientation on tax avoidance:

Evidence from a natural experiment

Gary Chen1Ani Manakyan Mathers2Bin Wang3Xiaohong (Sara) Wang4

Driehaus College of Business, DePaul

University, Chicago, Illinois, USA

Perdue School of Business, Salisbury

University, Salisbury, Maryland, USA

College of Business Administration,

Marquette University, Milwaukee,

Wisconsin, USA

College of Business and Technology,

Northeastern Illinois University, Chicago,

Illinois, USA

Correspondence

Xiaohong (Sara) Wang, College of

Business and Technology,Northeastern

Illinois University, Chicago,IL, USA.

Email: x-wang@neiu.edu

Abstract

We study the effect of stakeholder orientation on corporatetax avoidance. Using

the staggered passage of constituency statutes across U.S.states between  and

, we show that greater stakeholder orientation results in increasedtax avoid-

ance. We further find greater tax avoidance among firms with limited financial

resources and that employees benefit from the change. Our results are consistent

with stakeholder salience theory that resource-constrained managers prioritize

the claims of salient stakeholders, such as employees, at the expenseof secondary

stakeholders, such as the government.

KEYWORDS

constituency statutes, corporate social responsibility,effective tax rate, stakeholder orientation,

stakeholder salience, sustainability, tax avoidance

1 INTRODUCTION

Tax avoidance is a pervasive phenomenon in most tax

systems (Sikka, ; Weisbach, ). A study by the

Congressional Research Service suggests that US multina-

tional companies avoided paying the federal government

an estimated $ billion per year by shifting revenues

into low tax countries (Gravelle, ). From  through

, at least two-thirds of all US corporations had no

federal income tax liability (Government Accountability

Office, ). One proposal to tackle the prevalence of

tax avoidance is to cultivate a stakeholder-oriented cor-

porate culture that encourages companies to fulfill their

tax obligations as part of their corporate social respon-

sibility (CSR) (Desai, ). However, existing studies

examining the association between stakeholder orienta-

tion and tax avoidance have been unable to establish

causality and have garnered mixed results (e.g., Davis

et al., ; Hoi et al., ; Landry et al., ;Wat-

son, ). Using a quasi-natural experiment based on the

enactment of state-level constituency statutes that allow

firms’ managers and boards of directors to consider the

interests of non-shareholder stakeholders when making

business decisions, our study examines the causal effect of

stakeholder orientation on corporate tax avoidance.

The literature presents mixed views on the impact of

stakeholder orientation on tax avoidance. According to

stakeholder theory, managers should attend to the inter-

ests of stakeholders “who can affect or [are] affected by the

achievement of the organization’s objectives” (Freeman,

). Since tax jurisdictions (government) collect a large

proportion of corporate profits and are thus stakeholders

of a firm, greater stakeholder orientation may foster more

tax payment. On the other hand, firms may not necessar-

ily view tax payment as part of their social responsibilities.

There is ample anecdotal evidence of companies, such as

Microsoft and Starbucks, actively engaging in stakeholder-

oriented CSR activities while also allegedly participating

in aggressive tax avoidance (Bergin, ;Day,; Sikka,

).The stakeholder salience theory states that man-

agers prioritize perceived salient stakeholders when faced

with limited resources and competing stakeholder claims

(Mitchell et al., ). According to survey data, managers

generally view the government as a less important stake-

holder (Agle et al., ;Economist,). Thus, greater

stakeholder orientation may prompt managers to divert

J Corp Account Finance. ;:–. ©  Wiley PeriodicalsLLC. 37wileyonlinelibrary.com/journal/jcaf

38 CHEN  .

more resources to attend to the needs of more-salient

stakeholders (such as employees) at the expense of the

government, leading to greater tax avoidance.

Existing empirical work finds mixed results on the rela-

tion between stakeholder orientation and tax avoidance

and is largely unable to establish a causal link. Results

range from a positive relation (Davis et al., ;Lanis

& Richardson, ) to a negative relation (Hoi et al.,

; Lanis & Richardson, ) to a relation that is con-

tingent upon other factors such as profitability (Watson,

). Endogeneity is a challenge to establishing causal-

ity. For example, unobserved firm characteristics, such

as the availability of slack resources to attend to the

interests of non-shareholder stakeholders, may drive the

relation between stakeholder orientation and tax avoid-

ance (Watson, ). Alternatively, there could be reverse

causality if companies that aggressively avoid taxes use

certain stakeholder-oriented strategies as a form of insur-

ance to temper negative publicity about their tax avoidance

schemes (Fombrun et al., ; Godfrey et al., ).

Toestablish causality, we employ a quasi-natural experi-

ment based on the enactment of constituency statutes in 

states between  and . These constituency statutes

permit directors to consider not only the interests of share-

holders but also the interests of non-shareholder stake-

holders when making business decisions. The statutes

mark a state-level legal and corporate norm shift from

“shareholder primacy” toward greater stakeholder orien-

tation (Orts, ).While constituency statutes do not

compel firms to consider stakeholders in their decision-

making, several studies show that constituency statutes

lead to an increase in stakeholder-oriented policies at the

firm level, as well as increased stakeholder representation

on boards of directors (Flammer & Kacperczyk, ;Gao

et al., ; Luoma & Goodstein, ). Since states adopt

constituency statutes at different times, the adoption dates

introduce exogenous variation in the stakeholder orienta-

tion of firms incorporated in different states (Flammer &

Kacperczyk, ).

Using the difference-in-differences methodology, we

examine the impact of stakeholder orientation on tax

avoidance. To account for changes to the tax code and

accounting rules that could affect corporate tax payments

during our sample period, we control for year and state

of location interacted with year fixed effects.We also

control for firm fixed effects to address unobserved time-

invariant firm characteristics, such as corporate culture.

We find that firms in states with a constituency statute

(treatment group) experience an increase in tax avoid-

ance after its adoption compared to firms in states without

such a statute (control group).Our results suggest that

treatment firms, which experienced an exogenous shock

that increases their stakeholder orientation, decrease their

effective tax rates by an average of .– percentage points

(roughly .–. million dollars) compared to the effective

tax rates of similar control firms. We also find that an

increase in stakeholder orientation increases the book-tax

difference. Our results are robust to a battery of robustness

checks, including the use of an alternative sample period,

the exclusion of firms incorporated in Delaware,the exclu-

sion of firms incorporated in states whose constituency

statute is restricted to takeover cases, the inclusion of

industry trends, and alternative measures of tax avoid-

ance. We also conduct a placebo testthat randomly assigns

enactment years to states to verify that our results are

due to changes attributable to the constituency statute

rather than chance or other trends in corporate tax pay-

ments. Overall, our results suggest that greater stakeholder

orientation prompts more tax avoidance.

We further validate our baseline results by conduct-

ing additional tests. Stakeholder salience theory predicts

that managers prioritize salient stakeholders when con-

strained by limited resources (Mitchell et al., ). If the

stakeholder salience theory can explain our results, then

we would observe a stronger positive relation between

stakeholder orientation and tax avoidance among firms

with greater financial constraints, as those firms divert

resources from less important stakeholders (e.g., the gov-

ernment) to more salient stakeholders. Consistent with

this view,we find evidence that firms with greater financial

constraints engage in more tax avoidance after the statute

compared to less-constrained firms.

Wealso examine which stakeholders might benefit from

the enactment of constituency statutes. While we demon-

strate that tax payments to the government decrease, we

find that firms in states with a constituency statute score

higher on their overall commitment to other stakehold-

ers, as measured by the Kinder, Lydenberg, and Domini

(KLD) index. In particular, we find that the enactment

of constituency statutes is positively associated with the

employee dimensions of the KLD index. We further pro-

vide evidence that firms in states with a constituency

statute increase labor costs and employee retirement

benefits after the statute’s passage, which suggests that

employees benefit from the law change. These results are

consistent with predictions drawn from the stakeholder

salience theory and suggest that constituency statutes

benefit certain primary stakeholders such as employees.

Our paper contributes to the literature in the following

ways. First, given the prevalence of corporate tax avoid-

ance and the heated political debate about how to tackle

the issue, it is important to examine factors that impact

corporate tax avoidance. One aspect examined in the lit-

erature is the association between stakeholder orientation

and tax avoidance. However, the results have been mixed

and most prior studies do not attempt to establish causality.