Abstract
This study examines the endogenous relation between corporate social responsibility (CSR) and tax avoidance by focusing on a common strategy of corporate tax avoidance, i.e., establishing entities in offshore tax havens. Using hand-collected data on a sample of U.S. firms, we find that firms’ CSR ratings increase substantially in the two years after they first open tax haven affiliates. We provide evidence by using the controlled foreign corporations (CFC) look-through rule enacted by Congress in 2006 that facilitates offshore profit shifting. We find that firms that are affected by the CFC legislation increase their CSR practices in response. Overall, our results are consistent with the risk management theory, which argues that firms hedge against the potential negative consequences of aggressive tax avoidance practices through an increase in positive CSR activities.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
See “Is tax the next big CSR issue”? 19 June, 2014. (available at http://www.governanceanddevelopment.com/2014/06/is-tax-next-big-csr-issue.html).
These corporate tax avoidance activities have recently come under greater scrutiny. In 2011, Senator Carl Levin introduced the “Stop Tax Haven Abuse Act” while claiming that offshore tax abuses are not only undermining public confidence in the tax system, but also increasing the tax burden on middle-class America (https://www.gpo.gov/fdsys/pkg/BILLS-112s1346is/pdf/BILLS-112s1346is.pdf).
See BBC News (November 12th, 2012) for executive testimonies of these companies on tax avoidance (available at http://www.bbc.com/news/business-20288077). Also for the CSR transformation agenda of Starbucks and Amazon see the articles in USA Today (July 6th, 2014, available at http://www.usatoday.com/story/money/business/2014/07/06/why-its-hard-to-hate-starbucks/12022699/) and on the public relations website (November 1st, 2013, available at http://www.conecomm.com/amazon-csr), respectively.
Endogeneity is also a major problem for the relation between CSR and financial performance. For example, Garcia-Castro et al. (2010) deal with the endogeneity problem while linking social performance to financial performance. See Van Beurden and Gossling (2008) for a review of the relation between corporate social and financial performance.
After opening offshore affiliates in tax havens, firms can engage in tax avoidance using a variety of techniques, such as debt reallocation, earnings stripping, and income shifting. Since tax on the income of foreign subsidiaries (except for certain passive income) is deferred until repatriated, this income can avoid U.S. taxes. The taxation of passive income has also been reduced, through the use of “hybrid entities” that are treated differently in different jurisdictions. In addition, earnings from income that is taxed can often be shielded by foreign tax credits on other income. Thus, on average very little tax is paid on the foreign source income of U.S. firms with tax haven operations. Dyreng and Lindsey (2009) document that U.S. firms with operations in one or more tax havens enjoy low taxation and have about 1.5% lower tax burden than other U.S. firms without operations in tax havens. In an international sample, Col and Errunza (2014) show that the acquirers of tax haven firms decrease their ETRs on average by 4%.
The number is calculated as 1.316/2.26, where 2.26 is the mean CSR rating for the treatment firms reported in Panel C of Table 5.
Until recently, little attention was paid to the relation between CSR and tax avoidance (Dowling 2014). However, there are numerous studies that focus on CSR and tax avoidance separately. For example, Hong and Kostovetsky (2012) study how political values influence socially responsible investing (SRI). Hong et al. (2012) explore the relation between CSR and financial constraints. Albuquerque et al. (2014) relate CSR to firm value and systematic risk. Jamali et al. (2008) study the overlap between CSR and firms’ corporate governance. Masulis and Reza (2015) study how agency problems affect corporate philanthropy. Barnea and Rubin (2010) examine the relation between firms’ CSR ratings and their ownership and capital structures. Frank et al. (2009) investigate the link between aggressive financial reporting and CSR. See Hanlon and Heitzman (2010) and Margolis et al. (2007) for a comprehensive survey on tax research and CSR, respectively. For a survey of CSR in accounting studies, see Moser and Martin (2012).
The literature has also examined the role of top executives in firms’ aggressive tax policies. For example, Dyreng et al. (2010) find that top corporate executives who are responsible for the culture of the firm (or “tone at the top”) significantly affect firms’ tax avoidance policy. Rego and Wilson (2012) link top executive compensation and aggressive tax avoidance. Olsen and Stekelberg (2016) document the effect of CEO narcissism on the likelihood that the CEO's firm engages in corporate tax avoidance. .
Huseynov and Klamm (2012) find that the interaction of corporate governance strengths and diversity concerns with tax management fees negatively affects Cash ETRs. See Harjoto and Jo (2011) and Jensen (2002) for the relation between corporate governance and CSR as well as Jo and Harjoto (2011) on how the CSR and firm value relation is affected by corporate governance.
Most external rating agencies are likely to rate firms based on the same set of information that is voluntarily disclosed by firms. KLD provides CSR ratings for more than 3000 of the largest U.S. companies. Numerous researchers have pointed out that KLD provides an objective, uniform, and systematic assessment of the social behavior of firms (see Liston-Heyes and Ceton 2009). In addition, KLD’s social ratings are among the oldest and most influential and, by far, the most widely analyzed by academics (Chatterji et al. 2009).
U.S. Senate Permanent Subcommittee on Investigations (PSI), “EXHIBITS: Hearing on Offshore Profit Shifting and the U.S. Tax Code—Part 2 (Apple Inc.)” (May 21, 2013), pp. 5 & 6. https://info.publicintelligence.net/HSGAC-AppleOffshore.pdf.
We define these variables in detail in the next section as well as in the tables.
We thank our anonymous referees for helping us implement a more rigorous methodology.
Note that Huizinga and Voget (2009) also use SDC database to identify affiliates in tax implications of the parent–subsidiary relationship. We find that the coverage of foreign subsidiaries listed in the Exhibit 21 of firms’ 10‐K filings is, however, more accurate, as 10‐K filings are required by the SEC, whereas the SDC database may not include a subsidiary observation if it is not acquired through M&A. We are grateful to our anonymous referee for this suggestion.
We record the first year that a tax haven subsidiary (based on Dharmapala and Hines’ (2009) definition) shows up in firms’ records instead of recording all tax haven subsidiaries for each firm, which helps us save a tremendous amount of time and effort.
If a firm has all major financial variables except R&D, we set this variable equal to zero; that is we assume that when a company does not report these variables, it is because R&D spending is negligible.
When we look at 3-year windows (one year before and after the event) as well as the change in one year after the transaction, the results are consistent, but the magnitudes of the changes are smaller.
https://sites.google.com/site/scottdyreng/. Comparing our hand-collected data to those on Scott Dyreng’s website, we are able to accurately match the first year of operations for 92% of our sample. For those remaining, the reasons we could identify for the mismatches are due to differences in the start of sample years, definition of tax havens, and firm coverage. As a robustness check, we reran our tests after removing those with non-overlapping first-year numbers and all our results remain virtually unchanged.
For consistency, the tax haven definition is based on Dharmapala and Hines (2009). Note that Scott Dyreng’s website also defines tax havens with a larger set of countries/jurisdictions.
In order to ensure that the treatment and control groups follow a similar CSR trend before the exogenous shock, we also match them in the past CSR dimension by including lagged KLD scores in the probit regressions. This helps improve the average treatment effect and provides a better, more comparable control group. If we exclude past scores from selection regressions, our main results do not change.
The absolute bias is less than 5% except for market-to-book, leverage, and prior CSR scores, for which the biases are still not at large.
We also repeat our main tests using alternative CSR measures. The IVA (Intangible Value Assessment) score and its components such as environment, human capital, strategic governance, and stakeholder capital are obtained from the MSCI Environmental, Social, and Governance (ESG) Database. The sample is much smaller since for only a limited number of firms, the first year of tax haven subsidiary falls within the available IVA sample time period (2004-2010). Our main results continue to hold. For brevity, the results are not reported and are available upon request.
We thank the anonymous referee for bringing it to our attention.
Opler et al. (1999) argue that firms use their cash holdings for operational and liquidity needs as they grow. Therefore, it is important to focus on cash holdings that are in excess of operational and liquidity needs. Excess cash is defined as the residual from cross-sectional regressions of cash-to-assets ratios on market-to-book ratio, firm size, capital expenditure-to-assets ratio, net working capital-to-assets ratio, long-term debt, R&D expenses-to-sales, cashflow-to-total assets, and volatility of past industry cashflows.
The results are very similar when we conduct the tests on the overall KLD scores.
References
Albuquerque, R. A., Durnev, A., & Koskinen, Y. (2014). Corporate social responsibility and firm risk: Theory and empirical evidence. Working paper, University of Iowa.
Angrist, J. D., & Pischke, J. S. (2008). Mostly harmless econometrics: An empiricist’s companion. Princeton, NJ: Princeton University Press.
Bakke, T. E., Mahmudi, H., Fernando, C. S., & Salas, J. M. (2016). The causal effect of option pay on corporate risk management. Journal of Financial Economics, 120(3), 623–643.
Barnea, A., & Rubin, A. (2010). Corporate social responsibility as a conflict between shareholders. Journal of Business Ethics, 97(1), 71–86.
Bertrand, M., & Mullainathan, S. (2003). Enjoying the quiet life? Corporate governance and managerial preferences. Journal of Political Economy, 111(5), 1043–1075.
Besley, T., & Case, A. (2000). Unnatural experiments? Estimating the incidence of endogenous policies. Economic Journal, 110(467), 672–694.
Carroll, R., & Joulfaian, D. (2005). Taxes and corporate giving to charity. Public Finance Review, 33(3), 300–317.
Chatterji, A. K., Levine, D. I., & Toffel, M. W. (2009). How well do social ratings actually measure corporate social responsibility? Journal of Economics and Management Strategy, 18(1), 125–169.
Christensen, J., & Murphy, R. (2004). The social irresponsibility of corporate tax avoidance. Development, 47(3), 37–44.
Col, B., & Errunza, V. (2014). Havenly acquisitions. Working paper, McGill University.
Davis, A. K., Guenther, D. A., Krull, L. K., & Williams, B. M. (2016). Do socially responsible firms pay more taxes? Accounting Review, 91(1), 47–68.
Desai, M. A., & Dharmapala, D. (2009). Corporate tax avoidance and firm value. Review of Economics and Statistics, 91(3), 537–546.
Dharmapala, D., & Hines, J. R. (2009). Which countries become tax havens? Journal of Public Economics, 93(9), 1058–1068.
Dougherty, A. (2015). Look-through rule under I.R.C. Section 954(c)(6) is extended. Tax Matters by Aranson.
Dowling, G. R. (2014). The curious case of corporate tax avoidance: Is it socially irresponsible? Journal of Business Ethics, 124(1), 173–184.
Duhigg, C., & Kocieniewski, D. (2012, April 28). How Apple sidesteps billions in taxes. The New York Times,, 1–5.
Durnev, A., Li, T., & Magnan, M. (2011). Beyond tax avoidance: Offshore firms’ institutional environment and financial reporting quality. Working paper, University of Iowa.
Dyreng, S. D., Hanlon, M., & Maydew, E. L. (2010). The effects of executives on corporate tax avoidance. The Accounting Review, 85(4), 1163–1189.
Dyreng, S. D., & Lindsey, B. P. (2009). Using financial accounting data to examine the effect of foreign operations located in tax havens and other countries on U.S. multinational firms’ tax rates. Journal of Accounting Research, 47(5), 1283–1316.
Ebrahimi, H. (2012). Starbucks faces further criticism over its tax practices. Telegraph.
Frank, M. M., Lynch, L. J., & Rego, S. O. (2009). Tax reporting aggressiveness and its relation to aggressive financial reporting. The Accounting Review, 84(2), 467–496.
Garcia-Castro, R., Ariño, M. A., & Canela, M. A. (2010). Does social performance really lead to financial performance? Accounting for endogeneity. Journal of Business Ethics, 92(1), 107–126.
Godfrey, P. C. (2005). The relationship between corporate philanthropy and shareholder wealth: A risk management perspective. Academy of Management Review, 30(4), 777–798.
Gongloff, M. (2012). Apple, Google, Microsoft avoid taxes by keeping billions in profits offshore: Senate report. Huff Post Business.
Gravelle, J. (2015). Tax havens: International tax avoidance and evasion. Congressional Research Service Paper Series.
Grubert, H. (1998). Taxes and the division of foreign operating income among royalties, interest, dividends and retained earnings. Journal of Public Economics, 68(2), 269–290.
Hanlon, M., & Heitzman, S. (2010). A review of tax research. Journal of Accounting and Economics, 50(2), 127–178.
Hanlon, M., Maydew, E. L., & Saavedra, D. (2014). The taxman cometh: Does tax uncertainty affect corporate cash holdings? MIT working paper.
Hanlon, M., & Slemrod, J. (2009). What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement. Journal of Public Economics, 93(1), 126–141.
Harjoto, M. A., & Jo, H. (2011). Corporate governance and CSR nexus. Journal of Business Ethics, 100(1), 45–67.
Hermalin, B. (2001). Economics and corporate culture. In C. L. Cooper, S. Cartwright, & P. Christopher Earley (Eds.), The international handbook of organizational culture and climate. Chichester: Wiley.
Hines, J. R., & Rice, E. M. (1994). Fiscal paradise: Foreign tax havens and American business. Quarterly Journal of Economics, 109(1), 149–182.
Hoi, C. K., Wu, Q., & Zhang, H. (2013). Is corporate social responsibility (CSR) associated with tax avoidance? Evidence from irresponsible CSR activities. The Accounting Review, 88(6), 2025–2059.
Hong, H., & Kostovetsky, L. (2012). Red and blue investing: Values and finance. Journal of Financial Economics, 103(1), 1–19.
Hong, H., Kubik, J. D., & Scheinkman, J. A. (2012). Financial constraints on corporate goodness. Working paper, Princeton University.
Huizinga, H. P., & Voget, J. (2009). International taxation and the direction and volume of cross-border M&As. Journal of Finance, 64(3), 1217–1249.
Huseynov, F., & Klamm, B. K. (2012). Tax avoidance, tax management and corporate social responsibility. Journal of Corporate Finance, 18(4), 804–827.
Jamali, D., Safieddine, A. M., & Rabbath, M. (2008). Corporate governance and corporate social responsibility synergies and interrelationships. Corporate Governance: An International Review, 16(5), 443–459.
Jensen, M. C. (2002). Value maximization, stakeholder theory, and the corporate objective function. Business Ethics Quarterly, 12(2), 235–256.
Jo, H., & Harjoto, M. A. (2011). Corporate governance and firm value: The impact of corporate social responsibility. Journal of Business Ethics, 103(3), 351–383.
Kocieniewski, D. (2011a, March 24). GE’s strategies let it avoid taxes altogether. The New York Times, 10.
Kocieniewski, D. (2011b, May 2). U.S. business has high tax rates but pays less. The New York Times.
Kreps, D. M. (1996). Corporate culture and economic theory. In J. E. Alt & K. A. Shepsle (Eds.), Perspectives on positive political economy. Cambridge: Cambridge University Press.
Lanis, R., & Richardson, G. (2012). Corporate social responsibility and tax aggressiveness: An empirical analysis. Journal of Accounting and Public Policy, 31(1), 86–108.
Liston-Heyes, C., & Ceton, G. (2009). An investigation of real versus perceived CSP in S&P-500 firms. Journal of Business Ethics, 89(2), 283–296.
Macey, J. (2010). The value of reputation in corporate finance and investment banking (and the related roles of regulation and market efficiency). Journal of Applied Corporate Finance, 22(4), 18–29.
Margolis, J. D., Elfenbein, H. A., & Walsh, J. P. (2007). Does it pay to be good? A meta-analysis and redirection of research on the relationship between corporate social and financial performance. Working Paper, Ross School of Business, University of Michigan.
Masulis, R., & Reza, S. (2015). Agency problems of corporate philanthropy. Review of Financial Studies, 28(2), 592–636.
McCormack, J. (2011). GE filed 57,000-page tax return, paid no taxes on $14 billion in profits. The Weekly Standard.
Minor, D., & Morgan, J. (2011). CSR as reputation insurance: Primum non nocere. California Management Review, 53(3), 1–20.
Moser, D. V., & Martin, P. R. (2012). A broader perspective on corporate social responsibility research in accounting. The Accounting Review, 87(3), 797–806.
Moulds, J. (2012). Anger grows over large companies’ tax bills as attention turns to eBay and Ikea. The Guardian.
Olsen, K. J., & Stekelberg, J. (2016). CEO narcissism and corporate tax sheltering. The Journal of the American Taxation Association, 38(1), 1–22.
Opler, T., Pinkowitz, L., Stulz, R., & Williamson, R. (1999). The determinants and implications of corporate cash holdings. Journal of Financial Economics, 52(1), 3–46.
Preuss, L. (2010). Tax avoidance and corporate social responsibility: you can’t do both, or can you? Corporate Governance: The International Journal of Business in Society, 10(4), 365–374.
Preuss, L. (2012). Responsibility in paradise? The adoption of CSR tools by companies domiciled in tax havens. Journal of Business Ethics, 110(1), 1–14.
Rego, S. O., & Wilson, R. (2012). Equity risk incentives and corporate tax aggressiveness. Journal of Accounting Research, 50(3), 775–809.
Ritter, D. (2014). Why it is hard to hate Starbucks. USA Today.
Rosenbaum, P. R., & Rubin, D. B. (1983). The central role of the propensity score in observational studies for causal effects. Biometrika, 70(1), 41–55.
Rubin, A. (2008). Political views and corporate decision making: The case of corporate social responsibility. Financial Review, 43(3), 337–360.
Sikka, P. (2010). Smoke and mirrors: Corporate social responsibility and tax avoidance. Accounting Forum, 34(3), 153–168.
Van Beurden, P., & Gössling, T. (2008). The worth of values—a literature review on the relation between corporate social and financial performance. Journal of Business Ethics, 82(2), 407–424.
Waddock, S. A., & Graves, S. B. (1997). The corporate social performance-financial performance link. Strategic Management Journal, 18(4), 303–319.
Watson, L. (2015). Corporate social responsibility, tax avoidance, and earnings performance. Journal of the American Taxation Association, 37(2), 1–21.
Weisbach, D. A. (2002). An economic analysis of anti-tax-avoidance doctrines. American Law and Economics Review, 4(1), 88–115.
Acknowledgements
We thank Canadian Foundation for Governance Research (CFGR) for financial support.
Author information
Authors and Affiliations
Corresponding author
Appendices
Appendix 1: List of Tax-Haven Countries
Anguilla, Antigua and Barbuda, Arubaa, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Channel Islands, Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Hong Kongb, Irelandb, Isle of Man, Jordana, Lebanona, Liberia, Liechtenstein, Luxembourgb, Macaob, Maldives, Malta, Marshall Islands, Mauritiusa, Monaco, Montserrat, Naurua, Netherlands Antilles, Niuea, Panama, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Samoaa, San Marinoa, Seychellesa, Singaporeb, Switzerlandb, Tongaa, Turks and Caicos Islands, Vanuatu, Virgin Islands (U.S.)a |
Appendix 2: Components of CSR Criteria (KLD Scores)
Sub-criteria | Strengths | Concerns |
|---|---|---|
Community | Charitable giving Innovative giving Support for housing Support for education Non-U.S. charitable giving Other strengths | Investment controversies Negative economic impact Other concerns |
Corporate governance | Limit compensation Ownership strength Other strengths | High compensation Ownership concern Other concerns |
Diversity | CEO Promotion Board of directors Work/life benefits Women and minority Contracting Employment of the disabled Gay and lesbian policies Other strengths | Controversies Non-representation Board diversity concerns Other concerns |
Employee relations | Strength in union relations Cash profit sharing Employee involvement Retirement benefits strength Health and safety strength Other strengths | Concern in union relations Health and safety controversies Workforce reductions Retirement benefits concern Other concerns |
Environment | Beneficial products and services Pollution prevention Recycling Clean energy Other strengths | Hazardous waste Regulatory problems Ozone-depleting chemicals substantial Emissions Agricultural chemicals Climate change Other concerns |
Human rights | Indigenous people relations strength Labor rights Other strengths | Burma/Mexico concern Human rights violations International labor Indigenous people relations concern Other concerns |
Product quality/safety | Quality R&D/innovation Benefit to economically Disadvantaged Other strengths | Product safety Marketing/contracting Controversies Antitrust Other concerns |
Rights and permissions
About this article
Cite this article
Col, B., Patel, S. Going to Haven? Corporate Social Responsibility and Tax Avoidance. J Bus Ethics 154, 1033–1050 (2019). https://doi.org/10.1007/s10551-016-3393-2
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10551-016-3393-2