Taxes, Director Independence, and Firm Value: Evidence from Board Reforms Worldwide

Abstract

We examine whether variation in firms’ corporate governance mechanisms arising from exogenous board reforms explains differences in the level of corporate tax avoidance and the corresponding relation between tax savings and firm value. Our inquiry is enabled by a database of major board reforms from Fauver, Hung, Li, and Taboada (2016) that captures exogenous, country-level changes in board independence for a sample of 72,102 public corporations in 29 countries. We find that corporate tax avoidance decreases significantly after major board reforms. In particular, major board reforms involving board, audit committee independence, and reforms involving separation of the board chairman and chief executive officer roles reduce tax avoidance. “Comply-or-explain” reforms result in a greater reduction in tax avoidance than “rulebased” reforms. Furthermore, reforms with high impact and high compliance speed reduce tax avoidance more than those with low impact and low compliance speed. We document that the impact of board reforms on managers’ incentives to engage in tax avoidance is weaker for countries with stronger country-level investor protection mechanisms. We test the relation between tax avoidance and firm value associated with board reforms. We find that tax avoidance before (after) board reforms is negatively (positively) associated with firm value. This result is consistent with board reforms being associated with a reduction in agency conflicts associated with tax avoidance.