Alternative corporate governance: Does tax enforcement improve the performance of mergers and acquisitions in China?

Abstract

AbstractResearch Question/IssueWe study whether tax enforcement can function as a corporate governance mechanism in emerging countries with weak tax enforcement. In the case of China, we examine whether and how external monitoring by tax authorities constrains insiders' opportunistic behavior in corporate mergers and acquisitions (M&As).Research Findings/InsightsWe employ the implementation of the third stage of the China Tax Administration Information System (CTAIS‐3) as a quasi‐natural experiment and adopt a difference‐in‐differences (DID) approach. We find that strengthening tax enforcement by CTAIS‐3 can improve the efficiency of M&As by reducing agency problems in the decision‐making process. Our conclusions remain unchanged under a series of robustness checks. Moreover, the results show that the impact is mainly observed in regions with stronger local government taxation motivation and in firms with poorer internal or external governance and poorer accounting information.Theoretical/Academic ImplicationsWe find that strengthening tax enforcement can improve M&A decisions even in emerging markets, which provides direct evidence for the predictions from theory that tax authorities play a governance role in supervising corporate insiders. Our paper also extends the literature on the determinants of M&A performance from the perspective of tax authorities.Practitioner/Policy ImplicationsThis study has policy implications for governments around the world to improve corporate governance by strengthening tax enforcement. The Chinese government applying advanced information technology to tax enforcement can provide a reference for other countries.