How does the market for corporate control impact tax avoidance? Evidence from international M&A laws

As indicated in Table 10, our results are robust to restricting the sample period to that prior to the implementation of the EU Takeovers Directive in 2004.

For the control sample, we require each firm to have at least one year before and after 1998, the median enactment year of the enacting countries.

Our sample selection criteria result in an exclusion of one enacting country (Sri Lanka) and five non-enacting countries identified by Lel and Miller (2015) from our sample. Results are robust when we follow Lel and Miller (2015) and include these six countries.

We exclude observations with negative summed pre-tax income before extraordinary items. Results are similar if we require each of the three years to have positive pre-tax income.

We use GAAP-based ETRs instead of cash-based ETRs as the primary measure of tax avoidance because about half of our sample firms miss reporting tax payments, which significantly reduces the sample size (firm-year observations drop to 13,048 from 26,459) and may lead to sample-selection bias.

We do not use the country-level clustering scheme in our primary analyses because Petersen (2009) shows that standard errors based on fewer than approximately 40 clusters are likely to suffer from small sample bias. As discussed in Section 4.7, our results are robust to using alternative clustering schemes.

Khurana and Wang (2019) find an increase in leverage and a reduction in capital spending following the M&A law enactment. To shed light on whether adjustments in corporate financing and investment decisions are plausible economic channels by which the M&A law enactment reduces tax avoidance, we investigate whether the decrease in tax avoidance is greater when firms increase leverage and curtail capital expenditures more. In untabulated analysis we find insignificant differences in the effect of M&A enactment on tax avoidance across subsamples with above-sample-median or below-sample-median changes in leverage or capital expenditures. These results suggest that adjustments in leverage and capital investment are unlikely to be the channels through which M&A law enactments reduce tax avoidances.

Note that as Transition Year 2 captures the first year after the M&A enactment in a country, TAXAVOID in this year is computed based on information summed over the year prior to the M&A law enactment, the enactment event year, and the first year after the enactment.

Guenther et al. (2017) show that the volatility of cash tax rate is associated with future stock volatility. Accordingly, we re-estimate the regressions in Table 8 using the cash-based tax avoidance measure (Cash TAXAVOID) as the dependent variable, and find similar results. We do not use the cash-based tax avoidance measure as our primary dependent variable because, as noted earlier, many sample firms do not report cash taxes over our sample period, which may create sample-selection bias.

As defined by La Porta et al. (2006), the Anti-director Rights index is formed by adding one when (1) the country allows shareholders to mail their proxy vote; (2) shareholders are not required to deposit their shares prior to the General Shareholders’ Meeting; (3) cumulative voting or proportional representation of minorities on the board of directors is allowed; (4) an oppressed minorities mechanism is in place; (5) the minimum percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholders’ Meeting is less than or equal to 10% (the sample median); or (6) shareholders have preemptive rights that can only be waived by a shareholders meeting. The index ranges from zero to six. The Rule of Law index captures perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence (Kaufmann et al. 2010).

Alternatively, we use the comprehensive legal enforcement index compiled by La Porta et al. (2006), i.e., investor_pr, which is measured as the first principal component of private enforcement and anti-director rights. We find similar results.

In untabulated results, we also exclude firms with non-zero international sales generated from operations in foreign countries and find consistent results.