The nexus of political connections and corporate tax strategies in Pakistan

Abstract

PurposeExtant literature investigating the tax payment behaviour of politically connected firms largely supports the notion that politically connected firms have tax sheltering incentives, i.e. politically connected firms pay significantly less tax. Our paper adds to this stream of literature by considering the tax payment behaviour of two different groups of politically connected firms in Pakistan, viz. civil connected firms and military connected firms.Design/methodology/approachThe paper sheds light on the tax payment behaviour of politically connected firms and provides evidence that the tax incentives of politically connected firms are shaped by the institutional structure and contextual factors.FindingsThe results indicate that civil (military) connected firms pay significantly lower (higher) tax than non-connected firms. The findings hold in the face of a number of robustness tests, including the use of alternative proxies for the tax variable and endogeneity concerns.Originality/valueThese results make a significant contribution to the existing literature examining the tax payment behaviour of politically connected firms by providing evidence suggesting that tax sheltering is not the only viable option for politically connected firms; rather, some groups of connected firms have tax under-sheltering incentives. Our findings add to the political cost hypothesis and the signalling hypothesis in relation to tax payment incentives of politically connected firms.