Taking advantage of the agency conflicts between controlling shareholders and minority shareholders and the weak corporate governance in a transition economy, we investigate the relationship between tax avoidance (proxied by effective tax rates) and tunneling (proxied by related-party lending) from a principal-principal agency perspective. We find that corporate tax avoidance is positively associated with tunneling after controlling for firm characteristics, corporate governance, and institutional factors that affect tunneling. This relationship is more pronounced for firms with cash shortages and in periods with relatively weak investor protection. In addition, the value-enhancing implications of tax avoidance are reduced for firms in which tax avoidance is highly correlated with tunneling. By demonstrating the existence of tunneling-related tax avoidance and its economic consequences, this study sheds light on the emerging agency perspective on tax avoidance.
JEL Classifications: G18; H20; M41.
Local governments play dual, but conflicting, roles in China's tax system. That is, they are both tax collectors and controlling shareholders of firms subject to tax payments. We investigate how local governments balance their tax collection and tax avoidance incentives. We find that the conflicts between central and local governments arising from the 2002 tax sharing reform have led to more tax avoidance by local government-controlled firms, particularly when the local government's ownership percentage of the firms is higher than the tax sharing ratio. We also find evidence that the overall level of tax avoidance by local government-controlled firms in a region is positively associated with local fiscal deficits. As a high level of government ownership of corporations and intergovernmental tax sharing are common phenomena in many transitional economies, this study offers valuable insights into how the dual roles played by local governments affect tax policy enforcement in these economies.
JEL Classifications: H26; H71; M40; G38.
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