CEO Political Affiliation and Firms’ Tax Avoidance

Abstract

This paper studies the effects of CEOs’ political preferences on corporate tax avoidance. CEOs’ party affiliations are identified by their political donations during election cycles. Using four measures of tax avoidance from the literature (book-to-tax difference, shelter activities, permanent tax avoidance, and total tax avoidance), we find that firms led by Republican CEOs have significantly higher levels of tax avoidance by all measures, as opposed to firms led by CEOs with no obvious political preferences. These differences are particularly true when the CEO’s equity-based incentives are low, suggesting that risk incentives do not drive our findings. On the other hand, Democratic CEOs are associated with higher book-to-tax difference and more shelter activities, especially when CEOs’ risk incentives are high. These results suggest that Republican CEOs’ tax decisions are driven by political preferences and that Democratic CEOs’ tax decisions are driven by risk incentives. We also find some evidence to support a view of Democratic CEOs as aggressive in making tax policies. The results of the firm and CEO fixed-effect regressions confirm that it is the Republican CEOs’ political preference that causes significant changes in terms of firm-level discretionary tax avoidance. A similar pattern does not hold for Democratic CEOs. The robustness analysis of the 2003 dividend tax cut suggests that the significantly higher tax avoidance associated with Republican CEOs is not driven by this policy change. Lastly, the fixed-effect of Republican CEOs on tax avoidance is especially significant among well-governed firms.