Common Ownership and Tax Avoidance

Abstract

There have been significant priorities among tax practitioners and policymakers about corporate tax planning. There are many ways firms can avoid tax. However, we know very little about how firms learn about different tax avoidance mechanisms. One of the crucial channels is common owners, specifically common institutional blockholders (CIB’s), who potentially hold a momentous role in expediting the diffusion of tax avoidance knowledge across firms. Do firms engage in a similar level of tax avoidance if they share the same CIB’s? We investigate this question using the Common Ownership Data and Compustat/CRSP balance sheet data via Wharton Research Data Services (WRDS). Our final sample results in 23,603 (23,015) observations from 1999 to 2016 using GAAP ETR (cash ETR) as tax avoidance measure, from the raw data of around a 48million observations of holding information. Similar to a prior study by Cheng, Sun & Xie (2018), our empirical results support that firms follow their peers held by the same CIBs in making their tax avoidance strategies. We examine the causality of the peer effect on the focal firm. It is supplemented with other analyses using exogenous events, i.e., tax rate shock among peer firms. We acknowledge that companies operating in the same industry share the same firm-level characteristics; to proscribe this effect, our models look at peer firms with different SIC-code in relation to the focal firm. In addition, we conduct an event study on the investor level to observe blockholders adjust their portfolio weights when there is a shock in the focal firm’s ETR. However, the effect is limited to using cash ETR only, with blockholder adjust their portfolio when there is a negative cash ETR event. We also conduct an analysis that differentiates between short- and long-term blockholders. Our findings suggest that there is a positive interrelation between GAAP (Cash) ETR and PEER ETR. The SIC-code model indicates that investors are proved to drive the effect we see instead of latent industry-based characteristics. Furthermore, we find that short-term blockholders have more impact on the focal firm’s tax adjustment. Overall, our finding supports the hypothesis that firms engage in similar levels of tax avoidance if common blockholders own them. Our results support the tax avoidance effect is not driven by endogeneity issues. Further, our study aims to document a potentially vital channel for tax avoidance diffusion through CIBs. We hope that this thesis contributes to taxation and public finance by constructing and analysing the impact of common ownership through strategic tax avoidance mechanisms. It will also provide avenues to provide further research on this novel topic.