Coordination of Earnings, Regulatory Capital and Taxes in Private and Public Companies

Abstract

This study investigates whether the form of ownership in the life insurance industry (i.e., public, private or mutual) affects the pursuit of capital, earnings, and tax management goals between 1975 and 1991. Results indicate that differences resulting from ownership structure are most pronounced in the area of tax planning. Private stock companies use both policy reserves and reinsurance to manage taxes while public companies, on average, do not appear to manage taxes. I investigate whether the tax planning differences observed appear to be induced by compensation schemes used to control agency costs in public firms, or concerns with stock market interpretations, by studying the tax planning behavior of mutual firms. These firms have diffuse ownership structures, similar to those of public companies, and thus face similar agency problems. But since mutual firms are owned by their policyholders, they are not subject to the stock market concerns that affect public companies. If both private stock and mutual firms manage taxes more aggressively than public companies, the inference is that stock market concerns create the behavioral differences. However, if only private stock companies are aggressive tax managers, differences are more likely to stem from agency costs. My results indicate that mutual firms, like public companies, do not, on average, manage taxes. This outcome is consistent with incentive compensation contracts, designed to control agency costs, at least partly inducing differences in tax management behavior between private and public stock companies. I find support for capital management in all ownership structures. However, the specific tools employed vary across firm type. Private stock companies are more likely to manage capital through adjusting dividends while public companies and mutual firms are more likely to vary reinsurance levels. Mutual firms also used realized gains and losses to manage capital. All firm types appear to use policy reserves and reinsurance to smooth earnings.