Top

Review of Quantitative Finance and Accounting

Published in:

24-01-2018 | Original Research

Executive cash compensation and tax aggressiveness of Chinese firms

Authors: Wei Huang, Tingting Ying, Yun Shen

Published in: Review of Quantitative Finance and Accounting | Issue 4/2018

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

We examine the influence of corporate compensation policies on firms’ tax aggressiveness in an emerging market where executive compensation is primarily in cash form. Based on a hand-collected dataset of 958 firm-year observations of Chinese listed firms for the 2006–2012 period, we find that firms paying higher executive cash compensation are associated with lower tax aggressiveness. This relationship also holds for the excess cash compensation measures which control for executive shareholding, firm profitability, size, growth opportunity, and board independence. We further document that mutual funds ownership pressure firms paying higher compensation to reduce their tax aggressiveness, suggesting adverse selection by mutual funds on firms exhibiting risky tax avoidance activities. High leverage offsets the negative link between cash compensation and tax aggressiveness, indicating a complementary effect between debt and tax avoidance, and, hence, suggesting that creditor monitoring is weak. These results are robust to the system-GMM estimation, which simultaneously account for the endogeneity of executive compensation, tax aggressiveness, ownership and control, leverage, and corporate governance. Our findings on Chinese firms have important policy implications for developing countries around the world with concentrated ownership structure, weak institutional environment, widespread corruption, ineffective rule of law, and ongoing significant social and political transformation.

previous article Investors’ perception of CEO overconfidence: evidence from the cost of equity capital

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Available only for authorised users

Conyon and He (2011) and Chen et al. (2011) review the compensation disclosure requirement by the Chinese Securities Regulation Committee (CSRC). Under the Chinese context, CSRC defines “top management” as all executives, directors, and supervisors. Total compensation paid to executives and board members includes salary, bonus, stipends, and other benefits.

See Tang and Firth (2011) for an example of how to compute tax-effect BTDs and income-effect BTDs and the different results of those computations.

Available in Chinese at http://www.casc.gov.cn/kjfg/200607/t20060703_337130.htm.

For example, income not taxable is listed as a category of BTD. According to Article 26 of The Enterprise Income Tax Law, equity investment income such as dividend income and bonuses are not taxed. Therefore it is considered as a driver for this BTD category. Chinese listed firms do not disclose dividend income separately, but it is conflated with investment income. Hence, investment income is used as a proxy for the non-taxable income.

The Enterprise Income Tax Law, enacted in March 2007 and in force since January 2008 homogenized (gradually) the corporate income tax rate for both foreign-investment enterprises and domestic enterprises to 25%, while prior to this EIT Law, foreign-invested enterprises had benefitted from a lower tax rate of 15% and domestic enterprises had paid 33%. Unreported results suggest that using unadjusted total BTDs in our analysis does not affect our key findings.

Similarly, Tang (2015) regress total BTD on discretionary accruals and the difference between the statutory tax rate and the effective tax rate, and their interaction term to measure the mandatory book-tax conformity.

We use all firm-year observations of non-financial and non-distress firms (distress firms are denoted as ST/*ST) to estimate the predicted cash compensation in Eq. (3). The R-squared of the prediction regressions are 46.6, 36.1, and 50.5% for executive cash compensation (EXEPAY), director cash compensation (DIRPAY), and average per person leadership cash compensation (EDSPAY), respectively.

In all regressions we have controlled for the fixed industry and fixed year effects, omitted variables, particularly these are “fixed for given industry across years” and “fixed for given year across firms” are therefore controlled.

Chinese listed firms issue multiple classes of shares. Shares traded on stock exchanges are A-shares and B-shares. Non-tradable shares are classified as state-shares and legal person shares. The state, its agency, and SOEs control the majority of the listed firms.

We thank our reviewer for an excellent suggestions here. Further tests on subsamples classified by the median size value of the sample reveal that the negative compensation-tax aggressiveness relationship still holds among larger firms although weaker compared to the effect among smaller firms. Regression results on the subsamples are consistent with those on the full sample, as reported in “Appendix B3”, and, hence, are not reported in the paper to conserve space.

Unreported tests suggest that the interactions between cash compensation and mutual funds shareholding are insignificant determinants of tax aggressiveness suggesting mutual funds exert stronger monitoring pressure on the basis of excess compensation that is not due to firm performance but a reflection of agency costs and managerial power.

Unreported tests on subsamples classified by the median leverage ratio and the median mutual fund shareholdings ratio show that the negative compensation-tax aggressiveness relationship still holds among high leverage firms, but not among low mutual fund shareholding firms. These results are again largely consistent with the results on the full sample, as reported in Tables 6 and 7.

For example in model 2, the influence of executive cash compensation on tax aggressiveness is LOG(EXEPAY) * (− 0.362 − 1.559 * FUNDSH + 0.438 * HFUND). When HFUND equals to 1, the sensitivity of tax aggressiveness to LOG(EXEPAY) is higher (while negative) and depends on FUNDSH.

Arellano M, Bover O (1995) Another look at the instrumental variable estimation of error-components models. J Econom 68:29–51CrossRef

Armstrong CS, Blouin JL, Larcker DF (2012) The incentives for tax planning. J Account Econ 53:391–411CrossRef

Armstrong CS, Blouin JL, Jagolinzer AD, Larcker DF (2015) Corporate governance, incentives, and tax avoidance. J Account Econ 60:1–17CrossRef

Berger A, Hasan I, Zhou M (2009) Bank ownership and efficiency in China: what will happen in the world’s largest nation? J Bank Finance 33:113–130CrossRef

Blundell R, Bond S (1998) Initial conditions and moment restrictions in dynamic panel data models. J Econom 87:115–143CrossRef

Brick IE, Palmon O, Wald JK (2006) CEO compensation, director compensation, and firm performance: evidence of cronyism? J Bank Finance 12:403–426

Cai H, Liu Q (2009) Competition and tax avoidance: evidence from Chinese industrial firms. Econ J 119(537):764–795CrossRef

Cang Y, Chu Y, Lin TW (2014) An exploratory study of earnings management detectability, analyst coverage and the impact of IFRS adoption: evidence from China. J Account Public Policy 33(4):356–371CrossRef

Chan K, Chow L (1997) An empirical study of tax audits in China on international transfer pricing. J Account Econ 23(1):83–112CrossRef

Chan KH, Lin K, Mo PLL (2010) Will a departure from tax-based accounting encourage tax noncompliance? Archival evidence from a transition economy. J Account Econ 50:58–73CrossRef

Chan AL, Ding R, Hou W (2014) Does mutual fund ownership affect financial reporting quality for Chinese privately-owned enterprises? Int Rev Financ Anal 36:131–140CrossRef

Chen KP, Chu CYC (2005) Internal control versus external manipulation: a model of corporate income tax evasion. Rand J Econ 36:151–164

Chen S, Chen X, Cheng Q, Shevlin T (2010) Are family firms more tax aggressive than non-family firms? J Financ Econ 95(1):41–61CrossRef

Chen J, Ezzamel M, Cai Z (2011) Managerial power theory, tournament theory, and executive pay in China. J Corp Finance 17:1176–1199CrossRef

Chen H, Dong W, Han H, Zhou N (2016) A comprehensive and quantitative internal control index: construction, validation, and impact. Rev Quant Financ Account. https://doi.org/10.1007/s11156-016-0593-x CrossRef

Chien C, Lee CF, She CC (2016) Does corporate governance curb managers’ opportunistic behavior of exploiting inside information for early exercise of executive stock options? Rev Pac Basin Financ Markets Policies. https://doi.org/10.1142/s0219091516500065 CrossRef

Chung KH, Zhang H (2011) Corporate governance and institutional ownership. J Financ Quant Anal 46(1):247–273CrossRef

Chung H, Judge WQ, Li YH (2015) Voluntary disclosure, excess executive compensation and firm value. J Corp Finance 32:64–90CrossRef

Claessens S, Djankov S, Lang L (2000) The separation of ownership and control in East Asian corporations. J Financ Econ 58(1):81–112CrossRef

Cohen DA, Dey A, Lys TZ (2009) The Sarbanes Oxley Act of 2002: implications for compensation contracts and managerial risk taking, working paper

Conyon MJ, He L (2011) Executive compensation and corporate governance in China. J Corp Finance 17:1158–1175CrossRef

Core JE, Holthausen RW, Lacker DF (1999) Corporate governance, chief executive officer compensation and firm performance. J Financ Econ 51:371–406CrossRef

Crocker KJ, Slemrod J (2005) Corporate tax evasion with agency costs. J Public Econ 89:1593–1610CrossRef

Dechow P, Dichev ID (2002) The quality of accruals and earnings: the role of accrual estimation errors. Account Rev 77:35–59CrossRef

Desai M, Dharmapala D (2006) Corporate tax avoidance and high-powered incentives. J Financ Econ 79:145–179CrossRef

Desai M, Dharmapala D (2009) Corporate tax avoidance and firm value. Rev Econ Stat 91:537–546CrossRef

Ding S, Wu Z, Li Y, Jia C (2010) Executive compensation, supervisory board, and China’s governance reform: a legal approach perspective. Rev Quant Financ Account 35(4):445–471CrossRef

Duru A, Mansi S, Reeb D (2005) Earnings-based bonus plans and the agency cost of debt. J Account Public Policy 24:431–447CrossRef

Duru A, Iyengar RJ, Zampelli EM (2012) Performance choice, executive bonuses and corporate leverage. J Corp Finance 18:1286–1305CrossRef

Faccio M, Lang L (2002) The ultimate ownership of Western European corporations. J Financ Econ 65(3):365–395CrossRef

Firth M, Fung PMY, Rui OM (2006) Corporate performance and CEO compensation in China. J Corp Finance 12:693–714CrossRef

Firth M, Fung P, Rui O (2007) How ownership and corporate governance influence chief executive pay in China’s listed firms. J Bus Res 60:776–785CrossRef

Firth M, Gao J, Shen JH, Zhang YY (2016) Institutional stock ownership and firms’ cash dividend policies: evidence from China. J Bank Finance 65:91–107CrossRef

Frank MM, Lynch LJ, Rego SO (2009) Tax reporting aggressiveness and its relation to aggressive financial reporting. Account Rev 84:1–47CrossRef

García-Herrero A, Gavilá S, Santabárbara D (2009) What explains the low profitability of Chinese banks? J Bank Finance 33:2080–2092CrossRef

Graham J, Tucker A (2006) Tax shelters and corporate debt policy. J Financ Econ 118:107–155

Guo J (2016) Ultimate controlling shareholders and dividend payout policy in Chinese stock market. Rev Pac Basin Financ Markets Policies. https://doi.org/10.1142/s0219091516500089 CrossRef

Hanlon M, Slemrod J (2009) What does tax aggressive signal? Evidence from stock price reaction to news about tax aggressiveness. J Public Econ 93:126–141CrossRef

Hartzell JC, Starks LT (2003) Institutional investors and executive compensation. J Finance 58(6):2351–2374CrossRef

Hasan I, Hoi CK, Wu Q, Zhang H (2014) Beauty is in the eye of the beholder: the effect of corporate tax avoidance on the cost of bank loans. J Financ Econ 113:109–130CrossRef

Healy P (1985) The effect of bonus schemes on accounting decisions. J Account Econ 7:85–107CrossRef

Helwege J, Intintoli VJ, Zhang A (2012) Voting with their feet or activism? Institutional investors’ impact on CEO turnover. J Corp Finance 18(1):22–37CrossRef

Hou Q, Jin Q, Wang L (2014) Mandatory IFRS adoption and executive compensation: evidence from China. China J Account Res 7(1):9–29CrossRef

Houqe MN, Monem RM (2016) IFRS adoption, extent of disclosure, and perceived corruption: a cross-country study. Int J Account 51(3):363–378CrossRef

Huang W (2016) Tunneling through related-party loan guarantees: evidence from a quasi-experiment in China. Rev Quant Finance Account 47(3):857–884CrossRef

Huang W, Boateng A (2017) Executive and board shareholding, compensation, and analyst forecast of Chinese firms. Appl Econ 49(15):1459–1472CrossRef

Hung M, Wong TJ, Zhang F (2015) The value of political ties versus market credibility: evidence from corporate scandals in China. Contemp Account Res 32(4):1641–1675CrossRef

Jensen M, Meckling W (1976) Theory of the firm: managerial behavior, agency costs and ownership structure. J Financ Econ 3(4):305–360CrossRef

Jensen MC, Murphy KJ (1990) Performance pay and top-management incentives. J Political Econ 98:225–264CrossRef

Ji X, Lu W, Qu W (2017) Voluntary disclosure of internal control weakness and earnings quality: evidence from China. Int J Account 52(1):27–44CrossRef

Jiang G, Lee C, Yue H (2010) Tunneling through inter-corporate loans: the China experience. J Financ Econ 98:1–20CrossRef

Kabir R, Li H, Veld-Merkoulova YV (2013) Executive compensation and the cost of debt. J Bank Finance 37:2893–2907CrossRef

Kim C, Zhang L (2016) Corporate political connections and tax aggressiveness. Contemp Account Res 33(1):78–114CrossRef

Kim J, Li Y, Zhang L (2011) Corporate tax avoidance and stock price crash risk: firm-level analysis. J Financ Econ 100:639–662CrossRef

La Porta R, Lopez-de-Silanes F, Shleifer A (1999) Corporate ownership around the world. J Finance 54(2):471–516CrossRef

Lambert R, Larcker D (1987) An analysis of the use of accounting and market measures of performance in executive compensation contracts. J Account Res 25:85–125CrossRef

Leone AJ, Wu JS, Zimmerman JL (2006) Asymmetric sensitivity of CEO cash compensation to stock returns. J Account Econ 42:167–192CrossRef

Lim Y (2011) Tax avoidance, cost of debt and shareholder activism: evidence from Korea. J Bank Finance 35:456–470CrossRef

Lim Y (2012) Tax avoidance and underleverage puzzle: Korean evidence. Rev Quant Financ Acc 39(3):333–360CrossRef

Lin S, Tong N, Tucker AL (2014) Corporate tax aggression and debt. J Bank Finance 40:227–241CrossRef

Lins K (2003) Equity ownership and firm value in emerging markets. J Financ Quant Anal 38:159–184CrossRef

Liu Q, Tian G (2012) Controlling shareholder, expropriations and firm’s leverage decision: evidence from Chinese non-tradable share reform. J Corp Finance 18:782–803CrossRef

Minhat M, Dzolkarnaini N (2016) Is executive compensation a substitute governance mechanism to debt financing and leasing? Appl Econ 48(14):1293–1302CrossRef

Minnick K, Noga T (2010) Do corporate governance characteristics influence tax management? J Corp Finance 16:703–718CrossRef

Moore JA (2012) Empirical evidence on the impact of external monitoring on book–tax differences. Adv Account 28:254–269CrossRef

Pan X, Tian G (2017) Political connections and corporate investments: evidence from the recent anti-corruption campaign in China. J Bank Finance. https://doi.org/10.1016/j.jbankfin.2017.03.005 CrossRef

Peng S, Smith JVDL (2010) Chinese GAAP and IFRS: an analysis of the convergence process. J Int Account Audit Tax 19(1):16–34CrossRef

Phillips J (2003) Corporate tax planning effectiveness: the role of compensation-based incentives. Account Rev 78:847–874CrossRef

Qian M, Yeung B (2015) Bank financing and corporate governance. J Corp Finance 32:258–270CrossRef

Rego SO, Wilson R (2012) Equity risk incentives and corporate tax aggressiveness. J Account Res 50:775–810CrossRef

Richardson G, Taylor G, Lanis R (2013) The impact of board of director oversight characteristics on corporate tax aggressiveness: an empirical analysis. J Account Public Policy 32:68–88CrossRef

Richardson G, Lanis R, Leung SC (2014) Corporate tax aggressiveness, outside directors, and debt policy: an empirical analysis. J Corp Finance 25:107–121CrossRef

Shevlin T (2007) The future of tax research: from accounting professor’s perspective. J Am Tax Assoc 29:87–93CrossRef

Shleifer A, Vishny R (1993) Corruption. Q J Econ 108(3):599–617CrossRef

Sun Q, Tong WHS (2003) China share issue privatization: the extent of its success. J Financ Econ 70:183–222CrossRef

Tang YH (2015) Does book-tax conformity deter opportunistic book and tax reporting? An international analysis. Eur Account Rev 24(3):441–469CrossRef

Tang YH, Firth M (2011) Can book-tax difference capture earnings management and tax management? Empirical evidence from China. Int J Account 46:175–204CrossRef

Tang YH, Firth M (2012) Earnings persistence and stock market reactions to the different information in book-tax differences: evidence from China. Int J Account 47:369–397CrossRef

U.S. Congress (2002) The Sarbanes–Oxley Act of 2002. Public Law No.107-204. Government Printing Office, Washington

Wahab NSA, Holland K (2015) The persistence of book-tax differences. Br Account Rev 47(4):339–350CrossRef

Wilson R (2009) An examination of corporate tax shelter participants. Account Rev 84:969–999CrossRef

Windmeijer F (2005) A finite sample correction for the variance of linear efficient two-step GMM estimators. J Econom 126:25–51CrossRef

Yuan R, Xiao JZ, Zou H (2008) Mutual funds’ ownership and firm performance: evidence from China. J Bank Finance 32:1552–1565CrossRef

Yuan R, Xiao JZ, Milonas N, Zou JH (2009) The role of financial institutions in the corporate governance of listed Chinese companies. Br J Manag 20(4):562–580CrossRef

Title: Executive cash compensation and tax aggressiveness of Chinese firms
Authors: Wei Huang
Tingting Ying
Yun Shen
Publication date: 24-01-2018
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 4/2018
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-018-0700-2

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 4/2018

Corruption, governance, and public pension funds

Derivatives usage for banking industry: evidence from the European markets

Glamour versus value, market timing and firm performance: evidence from mergers and acquisitions

An analysis of proxy statement leadership structure justification disclosures

Managerial ability and firm risk-taking behavior

Managerial ability, information quality, and the design and pricing of corporate debt