Political Cost Theory Research Articles

The role of regional tax autonomy, firm size, and business groups in tax avoidance: evidence from Spain

ABSTRACT This paper investigates the influence of regional tax autonomy, firm size, and business group affiliation on corporate tax burden in a large sample of Spanish firms, including non-listed firms, from 2007 to 2016. Our findings reveal that firms located in tax-autonomous regions exhibit lower effective corporate tax rates (ETR), providing new empirical support for the horizontal tax competition theory. Additionally, we identify a positive relationship between firm size and corporate tax burden, aligning with the political cost theory. Furthermore, we find that group-affiliated firms face a higher ETR than independent firms, and that group affiliation attenuates the differences in the tax burden experienced by large and small firms.

Transfer pricing, earnings management and corporate governance among listed firms: Evidence from Ghana

PurposeThis study aims to examine the prevalence of transfer pricing and earnings management activities, and how they are impacted by corporate governance mechanisms.Design/methodology/approachUsing the political cost theory, the study provides insights into how opportunistic managerial behaviours which have a strong link to profit shifting and tax evasion are driven by corporate governance using data from 16 listed firms for the period 2008–2020.FindingsThe results reveal that the transaction-based transfer pricing model is better than the index-based model and the accrual-based earnings management model suits the political cost theory more than the real earnings management metric. Board size and female CEO increase transfer pricing aggressiveness but board independence, CEO tenure, CEO nationality and female Board Chairwomanship reduce transfer pricing aggressiveness. The findings also reveal the role of multinational enterprise status, private ownership, industry type, firm size, financial leverage, asset tangibility and firm age. For accrual-based earnings management, board independence, CEO tenure, and female Board Chairwomanship significantly decrease earnings management. Other factors include private ownership, firm size, and firm age.Practical implicationsThe findings of the study are relevant for shaping industry-level policies on earning management, transfer pricing and related-party transactions. Since these opportunistic managerial behaviours are the foremost drivers of tax avoidance and profit shifting, the findings of this study provide relevant insights for practitioners, tax and other regulatory authorities, policymakers and the academic community alike.Originality/valueThis is among the premier studies on the transfer pricing and earnings management nexus with corporate governance factors using the political cost theory, especially in the developing country context. It also reveals the significant impact of gender and suggests the need for gender diversity in corporate management.

Determinants of Effective Tax Rate: Empirical Evidence From Selected Manufacturing Industries in Bangladesh

Purpose: The objective of this study is to conduct an empirical investigation of financial and operational firm specific factors that have an impact on the effective tax rate (ETR) for Bangladeshi manufacturing firms operating in a variety of industries. Method: The study solely focused on three different production industries: Pharmaceuticals and Chemicals, Engineering, and Ceramics. At least six years’ set of panel data have been collected from each industry between 2016 and 2021 in order to conduct an analysis of the panel corrected standard error model (PCSE). Thus, the PCSE model is used to conduct an analysis on a total of 265 observations derived from 44 different company listed in DSE. Findings: Out of eight financial and operational factors, firm size and profitability has a significant positive correlation with ETR in practically every sector separately and collectively. The findings are supported by political cost theory that suggests large firms have to pay more taxes due to political attention. One exception has been found regarding Ceramics sector where firm size has insignificant negative impact on ETR. This is reinforced by the political power theory, which states that politically influential corporations are less likely to voluntarily pay taxes because of the incentives provided by the power they wield in politics. On the other hand, Interest coverage ratio, Interest to sales ratio, capital intensity, firm age leverage has also significant impact on the effective tax rate in both model ETR1 and ETR2 differently across sectors. This study also concludes that there is variation among industry to industry and little bit of year indicators. Novelty: The study investigates the factors of manufacturing companies empirically and contributes to the variety of taxation issues among various manufacturing sectors. According to the authors’ best knowledge, there has been very little research on taxes, hence this study is a completely new contribution to Bangladesh’s manufacturing sector. Keywords: Effective Tax Rate; Dhaka Stock Exchange; Political Cost Theory; Political Power Theory

Effective tax rate, board diversity, and firm performance: Evidence from the electric and electronic industry

This study examines the effect of effective tax rate (ETR) and board diversity on the performance of Malaysian public-listed companies (PLCs) in the electric and electronic (E&E) industry. The sample of this study comprised 51 E&E public companies listed in the Main Market of Bursa Malaysia during the financial periods 2018 and 2022. This study documents a significant positive relationship between firm performance and ETR, consistent with the political cost theory, suggesting that high-performing industries such as E&E are more at risk of political scrutiny and, hence, tend to pay higher amounts of tax despite the tax incentives provided by the government. Interestingly, foreign directors are negatively related to a firm’s performance. The possible explanation for this is that the E&E industry is highly regulated by the Malaysian government; hence, foreign directors’ contribution and authority to make independent strategic changes to drive the firm’s performance are limited. Finally, the effect of female directors on firm performance is found to be insignificant, possibly because, on average, only 10% of women are represented on the board of the E&E PLCs. The study findings are of significant interest and beneficial to policymakers, the government, and tax authorities in trying to understand the implications, assess the effectiveness, and tightly monitor the tax incentives and board diversity policy of the E&E companies.

Firm-specific Determinants of Aggressive Tax Management among East African Firms

Since tax represents an inflow of revenue to the government and an outflow of revenue to firms, factors that influence the tax planning activities of firms have gained considerable attention among management, shareholders, policymakers and researchers. Following the impact of taxation on an economy and a firm, the study investigated the factors that influence aggressive tax management practices of firms listed in East African economies. Data were collected from 99 firms for an 11-year period, from 2008 to 2018. Both cash effective tax rate and accounting effective rate were used as measures of tax planning. Multiple regression models were used for the estimation. The study results showed that smaller firms are more tax aggressive compared with larger firms, which is consistent with the political cost theory. This finding may alert policymakers and regulatory authorities (for example, revenue authorities) that small firms are most likely to avoid paying taxes compared with larger firms. This might be associated with fewer regulations and enforcements imposed on this category of business. The evidence further demonstrated that profitable firms are less tax aggressive. Consistent with the political power theory, this study has confirmed the view that profitable firms have enough earnings to pay their taxes and thus are less tax aggressive. The study further found that older firms are less involved in tax avoidance. This study has policy implications as it will assist both policymakers and firm management in their decision-making. Shareholders and firm management would benefit by understanding why some firms successfully reduce their tax burden compared to other firms.

A cohesive model of predicting tax evasion from the perspective of fraudulent financial reporting amongst small and medium sized enterprises

PurposeThe issue of tax evasion through fraudulent financial reporting committed by companies is a major concern facing the tax authority in Malaysia. As such, the purpose of this study is to propose a cohesive model of predicting tax evasion from the perspective of fraudulent financial reporting amongst small- and medium-sized enterprise (SME) taxpayers.Design/methodology/approachThe proposed model for this study is designed to explore the extent of the relationships between the independent variables: family ownership firms, company size, presence of tax professionals, company’s duration in business and frequency of tax audits and the moderating variable, i.e. tax audit officers’ level of competence; and the dependent variable, i.e. tax evasion from the perspective of fraudulent financial reporting. This study is grounded on four theories: agency theory, political cost theory, economic deterrence theory and competency theory. Data will be gathered from actual audit cases resolved by the Inland Revenue Board of Malaysia. Ordinary least square regression analysis is proposed for the investigation.FindingsThis study anticipates that family ownership firms, company size, presence of tax professionals, company’s duration in business and frequency of tax audits could be associated with tax evasion amongst SMEs in Malaysia. This study further proposes that highly competent tax audit officers could mitigate the relationship between frequency of tax audits and tax evasion practices amongst SMEs in Malaysia.Originality/valueThis study should be able to provide a cohesive model of predicting tax evasion from the perspective of fraudulent financial reporting amongst SMEs in Malaysia. Research on fraudulent financial reporting amongst SMEs is very limited, especially involving the level of competence of the tax audit officers; therefore, this study should contribute to the tax evasion literature by providing a comprehensive model of predicting tax evasion through fraudulent financial reporting using a Malaysian tax setting.

An emerging economy perspective on corporate sustainability reporting \u2013 main actors\u2019 views on the current state of affairs in Pakistan

The purpose of this paper is to explore the main actors’ views on the current state of sustainability reporting in a developing country context. This qualitative study is based on the interviews of 20 individuals and organizations from Pakistan who were identified as main actors involved in the practice of sustainability reporting. This paper draws on the arguments of multiple theoretical frameworks, including legitimacy theory, stakeholders’ theory, institutional theory, political cost theory, and signalling theory. Following a semi-structured interview protocol, main actors were asked to share their views on the drivers and barriers of sustainability reporting, sufficiency and suitability of sustainability-related regulation and standards, perceived benefits of sustainability reporting, level of stakeholder engagement and transparency. Interviews were then analysed to compare the viewpoints of different stakeholder groups on various issues. This paper concludes that, like other emerging and developing economies, the practice of sustainability reporting is largely driven by the external forces. Foreign buyers, international professional associations and standard-setting organizations are playing a pivotal role in the emergence and development of sustainability reporting. Sustainability reporting awards also played an important role as they provide the normative basis and intangible benefits for reporting. Despite these external forces driving the emergence and development of SR in Pakistan, the structural and cultural conditions that exist in the societal context of Pakistan significantly impact the disclosure practices and organizational rationales for SR. In particular, weak government structures, lack of awareness and interest in sustainability matters, lack of regulation, lack of enforcement capabilities, lack of a political will has been identified as the main barriers of SR. The paper explores the perceptions of both managerial and non-managerial stakeholders regarding the current state of sustainability reporting in Pakistan.

Corporate Tax Planning and Political Costs: Peer Effects of Foreign Institutional Ownership

We explore the relation between foreign institutional ownership and corporate tax planning. Using a comprehensive sample of international publicly listed firms, we find the presence of foreign institutional investors plays a disciplinary role by leading corporate managers to engage in a level of tax planning consistent with the average tax position of the company’s country and industry peers. Our findings hold for larger firms only, consistent with a political cost theory of tax planning. We address endogeneity concerns by exploiting multiple sources of exogenous variation in foreign institutional ownership. Our results overall suggest that foreign institutions act as effective monitors of managerial tax-related activity.

Drivers of Corporate Risk Disclosure in Indian Non-financial Companies: A Longitudinal Approach

The present study aims to identify the drivers of corporate risk disclosure in the Indian listed non-financial companies over a period of 6 years. A sample of 318 companies from Business Today’s list of top 500 companies has been analyzed using Panel data regression. Multiple theoretical perspectives have been employed such as agency, signaling, stakeholders and political cost theories in explaining the drivers of corporate risk disclosure. The findings provide crucial understanding for the investors, lenders and other prime stakeholders of key drivers of risk disclosure which will assist in the investment decision. The results conclude that corporate governance in the form of large boards, gender diversity in the boardrooms and independent directors on boards are positive drivers of risk information, whereas CEO duality restricts such information which is alarming. Larger, less profitable, low liquid and firms reporting more risk information in the past divulge more information on risk confronted by them. Analogously, the study widens the knowledge in the Indian context which possesses a lot of potentials to attract international investors who are in search of information to demarcate strongly managed companies than their counterparts.

Taxes and firm size: Political cost or political power?

Using a meta-regression analysis, we quantitatively review the empirical literature on the relation between effective tax rate (ETR) and firm size. Accounting literature offers two competing theories on this relation: The political cost theory, suggesting a positive size-ETR relation, and the political power theory, suggesting a negative size-ETR relation. Using a unique data set of 56 studies that do not show a clear tendency towards either of the two theories, we contribute to the discussion on the size-ETR relation in three ways: First, applying meta-regression analysis on a US meta-data set, we provide evidence supporting the political cost theory. Second, our analysis reveals factors that are possible sources of variation and bias in previous empirical studies; these findings can improve future empirical and analytical models. Third, we extend our analysis to a cross-country meta-data set; this extension enables us to investigate explanations for the two competing theories in more detail. We find that Hofstede’s cultural dimensions theory, a transparency index and a corruption index explain variation in the size-ETR relation. Independent of the two theories, we also find that tax planning aspects potentially affect the size-ETR relation. To our knowledge, these explanations have not yet been investigated in our research context.

The effects of corporate governance on environmental sustainability reporting: empirical evidence from South Asian countries

Comparatively less research has examined the effect of corporate governance (CG) elements on environmental sustainability reporting performance (ESRP) in South Asian (SA) countries. Further, no study in literature documents a cross-country examination of CG and ESRP in this region. The study takes three SA countries (Bangladesh, India, and Pakistan) and 88 listed organizations’ sustainability reports during the years 2009–2016 from the Global Reporting Initiative (GRI) database. The study considers a variety of mixed theoretical frameworks—i.e., agency, resource dependency, stakeholder, legitimacy and political cost theories—to indicate which ownership (foreign, institutional, director and family) and board characteristics (independence, size, diversity and committee) affect ESRP practices in the world’s most environmentally vulnerable region. Our empirical results indicate ESRP has a positive association with foreign and institutional ownership, board independence, and board size. Moreover, we find director share ownership significantly relates with ESRP. In contrast, our results also reveal no association between ESRP and family ownership, female directorship, and CSR and environmental committees. We conclude that more family control, a lack of female participation, and the unavailability of resourceful management personnel primarily impedes ESRP practices in the SA countries’ organizations. These findings have both theoretical and practical implications for academia, policy-makers, and corporate managers in this region.

Study of Effective Corporate Tax Rate and Its Influential Factors: Empirical Evidence from Emerging European Markets

ABSTRACTThis article examines the driving factors of the effective corporate tax rate (ECTR) for a sample of companies listed on five Eastern European stock exchanges (Romania, Hungary, Poland, Bulgaria, and Slovenia), covering the period 2000–2016. The empirical research covers variables regarding firm characteristics (e.g., profitability, efficiency of assets, indebtedness, liquidity, and solvency), firm-level controls, auditing fees, and the statutory rate. The estimated panel data models provide support for a positive link between the ECTR and profitability, debt, capital and inventory intensity, firm size, and statutory rate, strengthening the validity of political cost theory. Further, the negative link between market capitalization and assets growth supports the idea of political power theory.

Corporation effective tax rates and company size: evidence from Germany

We investigate the relationship between the effective tax rate (E.T.R.) and company size in Germany to test tax planning–political power versus political cost theories. In contrast to most studies in this field, which use linear approximations, this paper uses a quantile regression approach. We use data from Compustat, corresponding to non-financial listed companies during 1992–2009. The results indicate a nonlinear relation, with a positive sign for the first quantiles and a negative one in the last part of the distribution. Additionally, leverage, inventory intensity and return on assets are found to be significant determinants of the E.T.R.

Taxes and Firm Size: Political Cost or Political Power? A Meta-Regression Analysis

Using a meta-regression analysis, we quantitatively review the empirical literature on the relation between effective tax rates (ETRs) and firm size. Accounting literature offers two opposing theories on this relation: The political cost theory suggests a positive size-ETR relation because larger firms have higher political costs such as serving public scrutiny. The political power theory suggests a negative size-ETR relation because larger firms have more political power, e.g., to favorably influence legislation. Using a unique data set of 47 studies that do not show a clear tendency towards either of the two theories, we contribute to the discussion on the size-ETR relation in three ways: First, applying meta-regression analysis, we find a positive consensus estimate on the effect of firm size on ETR; thus, we provide evidence supporting the political cost theory. Second, our analysis reveals factors that are possible sources of variation and bias in previous empirical studies; these findings can improve future empirical and analytical models. Third, in further analyses, we find additional explanations for the two opposing theories such as tax planning, Hofstede’s cultural dimensions theory, and various governance indicators.

Healthcare Reform Proposal and the Behavior of Pharmaceutical Companies: The Role of Political Costs

SYNOPSIS This study examines whether drug makers took political and earnings management actions in response to the 2008 presidential campaign, which proposed major healthcare reforms. Specifically, we draw from the political cost theory and examine whether the level of political spending and the behavior of abnormal accruals and discretionary expense items in 2008 are consistent with a strategy by the drug makers to avert or reduce the adverse effect of any such reforms. A supplementary analysis considers whether the firms differ in their responses to the proposed reforms as a function of their exposure to the expected wave of patent expirations and preexisting market conditions. In particular, we examine a subset of pharmaceutical firms with elevated exposure to patent expirations or with severe market valuation problems and test the proposition that such firms will be less inclined to manage earnings downward for fear of a greater stock market penalty. We document above average increases in political spending and abnormal decreases in discretionary accruals for the drug firms in 2008; however, the subset of firms with elevated exposure to the patent expirations or with underperforming stocks had significantly smaller income-decreasing accruals during the same period. These latter results demonstrate the increased sensitivity of the subsets of firms to the capital market costs associated with managing earnings downward. Data Availability: Data are available from sources identified in the paper.

The tax burden of listed companies in China

This study examines factors affecting effective tax rates (ETRs) in China, using firms trading in the Shanghai and Shenzhen stock exchange markets from 1999 to 2008, and documents four key determinants, including (i) firm-specific attributes, (ii) ownership structure, (iii) industry upgrading and (iv) tax reforms in the form of cutting tax incentives. Consistent with prior findings, ETRs are positively related to firm size, as suggested by the political cost theory. Moreover, the relation between ETRs and financial leverage is nonlinear. ETRs are negatively related to financial leverage, but this relation becomes less negative as leverage keeps increasing. ETRs are also positively related to inventory intensity. On the other hand, ETRs are negatively related to the percentage of shares held by foreign stockholders. In addition, lower ETRs are found in high-tech industries which have been deemed more valuable by the government, and therefore receive more tax incentives. Finally, ETRs have increased followi...

Disappearing Subsidiaries: The Cases of Google and Oracle

From 2009 to 2010, 98 percent of Google’s and 99 percent of Oracle’s subsidiaries disappeared from the Exhibit 21s filed with their SEC Form 10Ks. However, a March 2012 search of available public company registries revealed that at least 65 percent of the missing subsidiaries remained active as of the companies’ 2010 filing dates. The decisions of Google and Oracle to disclose fewer subsidiaries stands in contrast to the literature documenting that firms providing more information enjoy lower costs of debt and equity capital. We employ legitimacy theory, institutional theory, agency theory, and political cost theory to explain the Google and Oracle decisions. Ultimately, however, we develop a new insight, that tax avoidance represents an additional source of capital beyond debt and equity, and this capital source exists in a unique setting that encourages less disclosure of certain types of information.

State ownership, tax status and size effect of effective tax rate in China

Political cost theory and political power theory are two views on the effect of firm size on effective tax rate (ETR) in extant literature. The size effect of ETR can be investigated further by focusing on the relationship between firms and the government. This paper uses state ownership and tax status to capture this relationship and examines how firm size, state ownership and tax status jointly affect effective tax rates. It is found that, when firms do not enjoy a preferential tax status, firm size is positively associated with effective tax rates for privately controlled firms and negatively associated for state-controlled firms. The results show that political cost theory explains the relationship between size and effective tax rate for privately controlled firms, whereas political power theory explains this relationship for state-controlled firms. For those firms that already enjoy a preferential tax status, there is no significant relationship between their size and their tax burdens.

Determinants of voluntary CSR disclosure: empirical evidence from Germany

Currently, companies spend a great deal of effort on Corporate Social Responsibility (CSR) disclosures. CSR disclosure relates to the provision of information on companies’ environmental and social performance. From an economic perspective, companies might disclose this information to avoid or decrease potential political costs. We construct a CSR disclosure index based on the Global Reporting Initiative (GRI) guidelines. Using content analysis, we analyze 130 listed German companies’ CSR disclosures (470 firm-year observations) to investigate the determinants of these voluntary disclosure activities. Our results show that, consistent with the political cost theory, German companies’ disclosures of all CSR issues are affected by their visibility, shareholder structure, and relationship with their US stakeholders. In addition, higher profitability is associated with more environmental disclosures. Finally, size and industry membership affect the amount of CSR disclosure.

Voluntary Disclosure in Annual Reports: The Association between Magnitude and Direction of Change in Corporate Financial Performance and Graph Use

SYNOPSIS: Prior archival research indicates that companies reporting increases in key financial performance variables (KFVs) are more likely to include graphs of these measures in their annual reports. This study expands prior work by using impression management and political cost theories to predict that the relationship between magnitude of KFV change and graphical disclosure differs, depending on whether the KFV is increasing or decreasing. Using data from 184 top U.S. companies that were in continual existence from 1999 to 2005, we replicate earlier findings that companies with increases in corporate performance are more likely to graph KFVs. Consistent with earlier theories of graphical disclosure, we find that companies with larger decreases in performance measures tend to be less likely to graph KFVs. At the same time, we extend prior research by showing that companies with larger increases in sales are more likely to graph these measures, but companies with larger increases in the “bottom line” measures of net income and earnings per share are less likely to graph KFVs. Our results indicate that the relationship between changes in corporate performance and graph usage is more complex than the simple directional relationships found in earlier research. These findings are consistent with impression management and political cost theories.