Essays on the Non-Financial Determinants of …...Essays on the Non-Financial Determinants of...

ESSAYS ON THE NON-FINANCIAL DETERMINANTS OF CORPORATE TAX PLANNING OUTCOMES

This thesis consists of four empirical papers investigating corporate tax behavior in Sweden.

“CEO Personal and Corporate Tax Behavior Consistency” explores whether and how CEOs’ personal tax preferences relate to corporate tax avoidance outcomes.

“CFO’s Role and Corporate Tax Outcomes” investigates whether corporate tax outcomes can be explained by CFO’s role as defined in the firm.

“Corporate Tax Outcomes and Executive Turnover: Evidence from Sweden” examines which executive, a CEO or a CFO, is perceived to be primarily re-sponsible for corporate tax outcomes, and what tax outcomes are preferred by corporate boards.

“Auditors and Tax Avoidance in Micro Firms” evaluates how the Swedish regulatory change of 2010 that allowed Swedish micro firms to opt out of audit affected their tax planning behavior.

is a researcher at the Department of Accounting at Stockholm School of Economics.

ESSAYS ON THE NON-FINANCIAL DETERMINANTS OF CORPORATE TAX

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ISBN 978-91-7731-105-8

DOCTORAL DISSERTATION IN BUSINESS ADMINISTRATION STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2018

Essays on the Non-Financial Determinants of Corporate Tax

Planning Outcomes

Milda Tylaitė

Akademisk avhandling

som för avläggande av ekonomie doktorsexamen vid Handelshögskolan i Stockholm framläggs för offentlig granskning

fredagen den 7 december 2018, kl 13.15, sal 750, Handelshögskolan,

Sveavägen 65, Stockholm


Planning Outcomes


Planning Outcomes

Milda Tylaitė

i i

Dissertation for the Degree of Doctor of Philosophy, Ph.D., in Business Administration Stockholm School of Economics, 2018

Essays on the Non-Financial Determinants of Corporate Tax Planning Outcomes © SSE and the author, 2018 ISBN 978-91-7731-105-8 (printed) ISBN 978-91-7731-106-5 (pdf)

Front cover illustration: © AtthameeNi/Shutterstock.com Back cover photo: ARCTISTIC/Photo: Nicklas Gustafsson

Printed by: BrandFactory, Gothenburg, 2018

Keywords: Tax planning, behavioral consistency, upper echelons theory

To my family

Foreword

This volume is the result of a research project carried out at the Department of Accounting at the Stockholm School of Economics (SSE).

This volume is submitted as a doctoral thesis at SSE. In keeping with the policies of SSE, the author has been entirely free to conduct and present her research in the manner of her choosing as an expression of her own ideas.

SSE is grateful for the financial support provided by Jan Wallanders and Tom Hedelius Foundation as well as Torsten Söderberg Foundation which have made it possible to carry out the project.

Göran Lindqvist Johnny Lind

Director of Research Professor and Head of the Stockholm School of Economics Department of Accounting

Acknowledgements

A PhD journey would not have been possible without the support of many people. First of all, I want to express my deepest gratitude to my main advisor Henrik Nilsson for teaching me how to do research, providing insights into the making of academic future, and always making sure that all is good both within and beoynd the SSE walls. I could not have expected to have a better advisor.

I am also grateful to my advisory committee members Juha-Pekka Kal-lunki and Ryan Wilson for guiding me during these years and for showing me not only how research is done, but also how it is communicated. These lessons and your overall support are invaluable.

During these six years my academic mindset has been shaped by numer-ous discussions with and insights by present and former colleagues at the Department of Accounting, in particular Kenth Skogsvik, Niclas Hellman, Walter Schuster, Ebba Sjögren, Henrik Andersson, Tomas Hjelström, Malin Lund, and Derya Vural. I am looking forward to continuing these discus-sions.

I am particularly grateful to Mattias Hamberg for generously providing me with some of the data used in this dissertation. I am hoping to be able to return the favour in the future.

Special thanks go to the participants of the Financial Analysis Brown Bag series: Péter Aleksziev, Ting Dong, Florian Eugster, Mariya Ivanova, and Hanna Setterberg. Research is always more exciting when discussed with great company (and with reasonably good coffee!).

This dissertation has also benefited from the comments and suggestions by fellow PhD students Patrik Tran and Kai Krauss. Thank you for being supportive colleagues in matters ranging from framing a research question to formatting page breaks.

vii i

I would also like to thank Anne Bengtsdotter, Christina Ekelin, Marie Tsujita Stephenson, and Elena Braccia for the administrative, organizational, and moral support during these years. You are magicians in what you do.

It turns out that PhD studies also have some unexpected social perks. I would therefore like to thank Tina Sigonius and Emilia Cederberg for their patience and encouragement when I was struggling with my first sentences in Swedish; Per Åhblom, Johan Graaf, and Shruti Kashyap for their delight-ful company, particularly after-hours; Christoph Schneider for, among other things, lovely promenades; and Egle Karmaziene for her advice, support, and no-nonsense Lithuanian attitude that made me see things more clearly.

Finally, I am immensely grateful to my family for their love and uncon-ditional support during the PhD journey. Despite having been exposed to extended research monologues as babies, my daughters Lina and Greta still appear to be my biggest fans. And I cannot thank my husband Karolis enough. Your patience, support, and reality checks have helped me to write this book and not lose my mind in the process. I could not have made this without you.

Stockholm, October 10, 2018

Milda Tylaitė

Contents

Introduction and Overview of the Dissertation ................................................ 1 1.1. Introduction .......................................................................................... 1 1.2. Increasing Public Awareness and Regulatory Efforts to Curb

Tax Avoidance ............................................................................................... 4 1.3. Defining and Measuring Corporate Tax Planning .......................... 6 1.4. The Three-Hurdle Corporate Tax Planning Framework ............. 14

1.4.1. Hurdle 1: Availability of Tax Planning Opportunities .......... 15 1.4.2. Hurdle 2: Desirability of Tax Planning .................................... 23 1.4.3. Hurdle 3: Implementability of Tax Planning Strategies ........ 32

1.5. The Swedish Setting ........................................................................... 35 1.5.1. Governance in Swedish Listed Firms ...................................... 35 1.5.2. Tax Environment in Sweden .................................................... 37

1.6. Papers – Extended Summaries ........................................................ 48 1.6.1. Paper I: CEO Personal and Corporate Tax Avoidance

Consistency ............................................................................................. 48 1.6.2. Paper II: CFO’s Role and Corporate Tax Outcomes ........... 50 1.6.3. Paper III: Corporate Tax Outcomes and Executive

Turnover: Evidence from Sweden ...................................................... 53 1.6.4. Paper IV: Auditors and Tax Avoidance in Micro Firms ...... 56

1.7. Concluding Comments ...................................................................... 58 1.7.1. Limitations ................................................................................... 59 1.7.2. Future Research ........................................................................... 60

References ............................................................................................................. 62

Paper I: CEO Personal and Corporate Tax Avoidance Consistency .......... 71 2.1. Introduction ........................................................................................ 72 2.2. Related Literature and Hypothesis Development ......................... 75

x

2.2.1. Personal Tax Behavior ................................................................ 75 2.2.2. Personal and Corporate Tax Behavior Consistency .............. 76

2.3. Research Design ................................................................................. 77 2.3.1. Data Sources ................................................................................ 77 2.3.2. Variable Measurement ................................................................ 79 2.3.3. Models ........................................................................................... 89

2.4. Empirical Results ................................................................................ 92 2.4.1. Determinants of Executives’ Personal Tax Avoidance ......... 92 2.4.2. Results from OLS Regressions .................................................. 93 2.4.3. Results from Quantile Regressions ........................................... 95 2.4.4. The Nature of the Consistency between CEOs’ Personal

and Corporate Tax Behavior ..................................................... 96 2.4.5. CEOs’ Personal Tax Avoidance and Conforming

Corporate Tax Avoidance ..................................................................... 99 2.5. Conclusions ......................................................................................... 99

References ............................................................................................................ 101

Appendix 2.1. Variable Descriptions ............................................................... 105

Tables and Figures .............................................................................................. 107

Paper II: CFO’s Role and Corporate Tax Outcomes ................................... 129 3.1. Introduction ...................................................................................... 130 3.2. Related Literature and Hypothesis Development ....................... 134

3.2.1. Related Studies ........................................................................... 134 3.2.2. Hypothesis Development ........................................................ 136

3.3. Research Design ............................................................................... 139 3.3.1. Data Sources .............................................................................. 139 3.3.2. Variable Construction ............................................................... 140 3.3.3. Models ......................................................................................... 146

3.4. Empirical Results .............................................................................. 147 3.4.1. Validation of the Measure of CFO’s Functional Scope ...... 147 3.4.2. Tests for the CFO’s Role and Corporate Tax Avoidance .. 150 3.4.3. Tests for the CFO’s Role and Corporate Tax Risk .............. 152 3.4.4. The CFO’s Role and her Corporate Priorities ...................... 153 3.4.5. Separating CFO’s Role from Other Firm Characteristics ... 155 3.4.6. Discussion of Empirical Results ............................................. 157

xi

3.5. Conclusions ....................................................................................... 158

References ........................................................................................................... 159

Appendix 3.1. Variable Descriptions .............................................................. 164

Tables ................................................................................................................... 166

Paper III: Corporate Tax Outcomes and Executive Turnover: Evidence from Sweden ................................................................................. 181 4.1. Introduction ...................................................................................... 182 4.2. Related Literature and Hypothesis Development ....................... 186

4.2.1. Determinants of Executive Turnover .................................... 186 4.2.2. Corporate Tax Behavior and Forced Executive Turnover 188 4.2.3. Corporate Tax Behavior and Voluntary Turnover .............. 190

4.3. Research Design ............................................................................... 191 4.3.1. Sample Construction ................................................................ 191 4.3.2. Variable Measurement .............................................................. 193 4.3.3. Models ........................................................................................ 195

4.4. Empirical Results .............................................................................. 196 4.5.1. Descriptive Statistics ................................................................. 196 4.5.2. CEO Turnover Investigations ................................................ 198 4.5.3. CFO Turnover Investigations ................................................. 199 4.5.4. Additional analysis .................................................................... 200

4.5. Conclusions ....................................................................................... 207

References ........................................................................................................... 210

Appendix 4.1. Variable Descriptions .............................................................. 213

Tables and Figures ............................................................................................. 216

Paper IV: Auditors and Tax Avoidance in Micro Firms .............................. 237 5.1. Introduction ...................................................................................... 238 5.2. Related Literature and Hypothesis Development ....................... 243

5.2.1. Tax Planning in Small Private Firms ...................................... 243 5.2.2. Voluntary Audit Choice and Corporate Tax Planning

Behavior ...................................................................................... 245 5.3. Institutional Setting .......................................................................... 246

5.3.1. The 2010 Audit Regulation Change ....................................... 246

xii

5.3.2. Tax Planning and Tax Reporting in Swedish Micro Firms . 248 5.4. Research Design ............................................................................... 250

5.4.1. Data Sources .............................................................................. 250 5.4.2. Sample Construction ................................................................. 250 5.4.3. Variable Construction ............................................................... 252 5.4.4. Model ........................................................................................... 257

5.5. Empirical Results .............................................................................. 258 5.5.1. Parallel Trends Before the Regulation Change ..................... 258 5.5.2. Descriptive Statistics ................................................................. 259 5.5.3. Main Tests: Voluntary Audit and Tax Outcomes ................ 259 5.5.4. Additional Analysis and Robustness Checks ........................ 264

5.6. Conclusions ....................................................................................... 266

References ............................................................................................................ 268

Appendix 5.1. Variable Descriptions ............................................................... 271

Appendix 5.2. Untaxed Reserves: a Numeric Example ................................ 272

Tables ................................................................................................................... 274

Chapter 1

Introduction and Overview of the Dissertation

1.1. Introduction

What shapes corporate tax planning outcomes? And why do some firms ex-hibit more aggressive tax planning than others? These questions are growing in importance due to increasing public attention to corporate tax behavior and changing perceptions of how such behavior should look like. In this dis-sertation, I investigate the non-financial determinants of corporate tax plan-ning behavior in a Swedish setting. The dissertation consists of the following papers:

• Paper I: CEO Personal and Corporate Tax Avoidance Consistency

• Paper II: CFO’s Role and Corporate Tax Outcomes

• Paper III: Corporate Tax Outcomes and Executive Turnover: Evi-dence from Sweden

• Paper IV: Auditors and Tax Avoidance in Micro Firms

2 ESSAYS ON THE NON-FINANCIAL DETERMINANTS OF CORPORATE TAX PLANNING OUTCOMES

The main theme in this dissertation is the notion that corporate tax behavior is shaped by a multitude of factors that go beyond purely financial consider-ations. Thus, the first paper (Paper I)1 investigates whether personal tax pref-erences of the CEOs in listed Swedish firms during 1999-2007 can explain the corporate tax avoidance outcomes of their firms. Indeed, the findings suggest that executives that are personally more tax conscious run companies that have higher levels of tax avoidance; moreover, such association appears to be a result of a CEO imprint in the firm rather than firms choosing the CEOs that best match their tax planning preferences.

In the second paper (Paper II), I turn to the CFO’s role and its associa-tions with tax planning outcomes which I investigate using the same sample of Swedish listed firms during 1999-2007. This study is based on the propo-sition that CFO’s involvement is critical for the implementation of tax plan-ning strategies (Feller & Schanz, 2017), and the observation that CFO’s role can take a variety of forms. Two main observations emerge from this study. First, I show that the CFO’s functional scope (with, I suggest, reflects the degree of attention paid to tax planning) and the CFO’s power (which argu-ably reflects the CFO’s ability to influence corporate outcomes) are signifi-cantly related to corporate tax outcomes. Second, and related to Paper I, I find some evidence that the CFO’s role and CEO preferences can function as substitutes in achieving (arguably) optimal corporate tax behavior. These two papers therefore show how managerial preferences and organizational structures can explain corporate tax outcomes.

In the third paper (Paper III), I investigate what kinds of tax planning outcomes are preferred by the corporate boards that are expected to guide their firms with shareholder interests at heart. I thus investigate whether CEO and CFO turnover in Swedish listed firms during 2000-2007 can be related to foregone shareholder value creation opportunities, tax-related rep-utational damage, and tax-related risk. I find that forced executive turnovers are preceded by extreme low tax avoidance levels which may be indicative of foregone shareholder value creation opportunities. I also find that executives

1 Co-authored by Tomas Hjelström, Juha-Pekka Kallunki, and Henrik Nilsson.

CHAPTER 1 3

are punished for high tax risk which yields uncertainty about future tax out-comes and therefore may also reduce shareholder value. However, I find no support for the proposition that executives are punished for extreme high (but arguably legal) tax avoidance. Instead, I find some evidence that execu-tives are rewarded, either via promotions or compensation, for such behav-ior. Such finding contrasts the previous literature and the proposition that high levels of tax avoidance yield reputational costs, which then may be re-flected in executive dismissals. I discuss potential reasons for these differ-ences in findings in the paper summaries at the end of this chapter as well as in Paper III further in this book.

The final paper (Paper IV)2 investigates the role of the auditor in corpo-rate tax planning behavior. To that end, we utilize the sample of micro Swe-dish firms during 2006-2014 and investigate how audit regulation change that took place in 2010 affected corporate tax planning behavior. The key finding emerging from this study suggests that auditors, in efforts to retain their cli-ents following the regulation change, provide additional advice on tax plan-ning opportunities available to those clients.

The four empirical papers that comprise this dissertation thus shed some additional light on what role managers, organizational structures, and audi-tors play in corporate tax planning outcomes. However, tax planning out-comes can take multiple forms, whereas corporate tax planning in itself is a complex, multi-layered process. The key purpose of this introductory chapter is therefore twofold. First, this chapter is intended to provide a review of the outcomes that corporate tax planning processes may yield, and discuss the empirical measures used to capture those outcomes. Further in the disserta-tion, I investigate the drivers of these different types of tax outcomes. The second aim of this chapter is to provide a broader unifying view on how and why specific approaches to corporate tax planning emerge in the firm. To that end, I utilize the three-hurdle tax planning framework developed by Feller and Schanz (2017). As per this framework, corporate tax planning strategies are subject to three sequential hurdles (availability, desirability, and implementability) that determine whether a specific tax planning strategy will

2 Co-authored by Ting Dong and Ryan Wilson.


be adopted in the firm. The three-hurdle framework therefore suggests a hi-erarchical view on corporate tax planning, and provides a structured way to reconcile some of the empirical findings in corporate tax planning literature. It also provides a conceptual basis for the methodological choices made in this dissertation; I discuss some of these choices in Section 1.4.

I thus structure this chapter as follows. First, I provide a broader over-view of the extent of corporate tax avoidance taking place internationally. To provide basis for the discussion of tax research, I then review the common approaches to identifying and quantifying tax planning behavior. Next, I pre-sent the three-hurdle framework of tax planning behavior (Feller & Schanz, 2017). I use this framework to review the contemporary corporate tax plan-ning literature as well as highlight the positioning of the present dissertation in this literature. Finally, I discuss the Swedish setting on which this disserta-tion is based, and provide an extended summary of the papers that comprise this book. In the final section, I discuss the contributions as well as limita-tions of this dissertation, and offer some suggestions for further research.

1.2. Increasing Public Awareness and Regulatory Efforts to Curb Tax Avoidance

During the recent years, corporate tax avoidance and evasion have received unprecedented public exposure. In 2014, the International Consortium of Investigative Journalists revealed that tax rulings in Luxembourg facilitated substantial income tax savings for the multinational firms incorporated in this country. LuxLeaks, as they were popularly called, caused public outrage, even though advance tax rulings that the investigation revealed were (argua-bly) legal and contained no risk for the firms named in those rulings. Soon after, in early 2015, another journalistic investigation revealed a giant tax eva-sion scheme set up for private and corporate clients alike by the Swiss sub-sidiary of HSBC, a British-origin multinational bank. In 2016, the Panama Papers leak made information about offshore entities in Panama public, and revealed how some of these offshore companies were used for financial fraud, tax evasion, and other illegal purposes. Finally, in 2017, the Paradise

CHAPTER 1 5

Papers leak revealed information about the use of offshore companies and tax avoidance schemes from 19 tax havens.

In light of the extent at which both personal and corporate tax avoidance appears to take place, it is no surprise that the recent decades have seen nu-merous political and regulatory initiatives aimed at limiting such practices. For instance, in the US, firms3 are since 2007 required to provide greater disclosure on their tax reporting choices, including uncertain tax benefits as defined in FIN 48 (Wilde & Wilson, 2018). Organization for Economic Co-operation and Development (OECD) has also oriented its actions towards curbing international corporate tax avoidance via information exchange, in-troduction of country-by-country tax reporting requirements, and transfer pricing regulations aimed at limiting income shifting (OECD, 2013). Individ-ual countries also gradually modify their local regulations so as to reduce in-ternational tax avoidance: for instance, Sweden has in 2009 introduced so-called interest stripping restrictions and in 2019, new regulation limiting in-terest deductibility is about to come into effect. At a local firm level, tax au-thorities have also started making more use of the technology in efforts to limit corporate tax avoidance at small and medium enterprises (SMEs), where such behavior often takes simple, but difficult to prevent forms, such as un-derreporting of sales, or over-reporting of expenses.

As a result of these developments, contemporary corporate decision makers appear to be subject to different types of pressures related to tax planning outcomes. On the one hand, firms are expected to create share-holder value, thus implying low desired tax expenses. On the other hand, regulatory initiatives make tax avoidance costlier; finally, actual and perceived reputational pressures create additional risks related to tax planning. Corpo-rate tax planning is thus becoming an increasingly demanding activity that must address compliance, profitability, and risk dimensions of stakeholder expectations (Donohoe, McGill, & Outslay, 2014).

As firms, regulators, and society at large perceive corporate tax planning activities and their outcomes as increasingly important, academic research has also responded to such developments by investigating why and when

3 Initially only public firms; currently, the requirement applies to all firms reporting

under GAAP.


firms engage in corporate tax avoidance, how stakeholders perceive various types of corporate tax behavior, and how such behavior can be identified. Numerous factors, such as firm level characteristics, governance structures, regulations, managerial intentions, as well as external stakeholders’ pressures, have been related to corporate tax planning outcomes. I review this literature using the three-hurdle tax planning framework developed by Feller and Schanz (2017) further in this chapter, see Section 1.4.

1.3. Defining and Measuring Corporate Tax Planning

Before discussing the three-hurdle framework of corporate tax planning, it is crucial to define what the concept of tax planning represents. Any firm sub-ject to tax obligations also has a naturally developed or explicitly formulated tax planning strategy4. Such tax planning strategy covers all activities and con-siderations related to assessing the amount of income taxes to be reported and paid. Tax planning is therefore an overarching concept that includes cor-porate tax goals as well as approaches to achieving those goals.

Corporate tax goals vary greatly across firms. The goal of tax planning that receives most attention from practitioners and academics alike is tax avoidance. Other goals of tax planning can be, for instance, tax risk manage-ment (i.e. maintaining the variation and uncertainty of tax outcomes at a cer-tain level), or tax compliance, i.e. ensuring that the firm fully complies with all tax reporting requirements. In certain cases, tax planning goals can also extend towards other business considerations. For instance, certain firms treat their tax obligation as a part of corporate social responsibility, and thus communicate their tax payments as reflective of their societal engagement. At a more operational level, tax planning techniques can also be used to en-sure sufficient financial liquidity. In this dissertation, I concentrate on tax avoidance and tax risk dimensions of tax planning.

4 Further in the dissertation, I refer to tax planning strategy and tax planning inter-

changeably.

CHAPTER 1 7

Following Dyreng, Hanlon, and Maydew (2010), I define corporate tax avoidance as any behavior that reduces the corporate tax bill. Importantly, such definition of tax avoidance does not imply that tax avoidance is illegal; rather, it suggests that firms use various legal tools that are available to them in order to reduce their tax burden. To differentiate between legal and illegal corporate tax avoidance behavior, I refer to the latter one as tax evasion.

Contemporary literature identifies two main types of corporate tax avoid-ance: conforming and non-conforming tax avoidance. Non-conforming tax avoidance5 is defined as the deviation of corporate tax position from the one that is expected based on the book pre-tax income and the statutory tax rate. It is the type of tax avoidance that is typically investigated in accounting and taxation literature. The primary reason behind such approach has to do with the type of firms investigated in such literature. Contemporary studies pri-marily investigate the tax behavior of listed firms that are likely to prioritize this kind of tax avoidance. Listed firms’ aim is to achieve certain level of earnings; in the tax context, such outcome can be achieved by utilizing the differences in financial and tax reporting rules. The firm thus may aim to report high pretax (book) income and low taxable income; the outcome of this kind of behavior is thus referred to as non-conforming tax avoidance.

Conforming tax avoidance behavior, on the other hand, refers to situa-tions when firms choose to report lower performance (i.e. by lowering re-ported revenue and/or increasing reported expenses) in both their financial statements and tax filings with the goal of reducing their income tax burden. Such behavior is more likely to be observed in private firms where capital market pressures are low and owners are well informed (Badertscher, Katz, Rego, & Wilson, 2017). This type of behavior is thus conceptually different from non-conforming tax avoidance since the need to report high book earn-ings does not play a (significant) role in such tax decision making; as a result, it is not captured by standard tax measures which mostly are designed to describe non-conforming tax avoidance. Recently, an effort has been made to back out the level of conforming tax avoidance from tax burden, operating

5 The term of non-conformity is used in this setting since deviation from statutory tax rate arises due to differences (or non-conformity) between financial and tax reporting. Due to differences in there reporting requirements, the pre-tax income reported in the financial statements and taxable income reported in tax filings often are not the same.


performance, and degree of non-conforming tax avoidance (Badertscher et al., 2017). This is the approach I also use in this dissertation.

Finally, corporate tax risk refers to the uncertainty of tax outcomes. Such uncertainty can arise either from volatility of tax outcomes (e.g. when effec-tive tax rate is unpredictable), or from tax positions that are likely to be dis-puted by the tax authorities, thus yielding tax fines6 and, in extreme cases, impaired corporate reputation. Notably, tax risk emerging from the volatility of tax outcomes (as opposed to tax fines) does not necessarily mean that the firm is inefficient in its tax management. Such volatility can emerge from using ad hoc tax saving opportunities that are not questionable (Blouin, 2014)7; the risk, however, arises when shareholders do not have access to tax plan-ning information and thus may perceive such uncertainty negatively.

In Table 1.1, I review the empirical proxies for tax avoidance and tax risk most frequently used in contemporary corporate tax literature. Based on this review, I highlight several observations about the empirical use of tax plan-ning measures. First, in line with the fact that most studies during the recent decades have aimed to identify the levels of non-conforming tax avoidance, the number of proxies intended to capture this type of behavior is highest. During the last decade, the discussion about tax risk has intensified; as a re-sult, a spectrum of proxies for this construct has also been broadening. Sec-ond, most proxies are developed in the studies investigating U.S. firms’ tax behavior. This imposes a limitation on the use of certain mesures in an inter-national setting, particularly when they are based on the U.S.-specific regula-tion (such as FIN 48 disclosure requirements), or U.S.-based estimates (such as tax shelter score calculation). Finally, several studies investigate how vari-ous proxies of tax planning behavior are related, but their findings yield

6 Which typically result in larger effective tax rates. For instance, SCA AB, a Swedish

listed company, because of a lost dispute with a Swedish Tax Agency, has reported the effective tax rate of 42% in 2016. In comparison, its effective tax rate in 2014 and 2015 was 24.3% and 27.4%, respectively. See Table 1.1 for a review of other tax risk proxies.

7 For instance, in a Swedish setting, cash tax payments can be temporarily reduced by allocating up to 25% of taxable income to untaxed reserves. Such approach contains no legal risks.

CHAPTER 1 9

mixed results (Dyreng, Hanlon, & Maydew, 2008; Dyreng, Hanlon, & Maydew, 2018; Guenther, Matsunaga, & Williams, 2016).

These observations also guide the choice of tax planning outcome prox-ies in this dissertation. Since different measures appear to capture slightly different dimensions of tax planning behavior, investigations of broad tax avoidance or tax risk may benefit from the use of several proxies capturing that kind of behavior. Indeed, many studies, including Rego and Wilson (2012), Chyz and Gaertner (2018), Chyz (2013), and Armstrong et al. (2012), use multiple proxies to capture tax planning outcomes. In this dissertation, I also use multiple measures to identify tax avoidance (and thus use effective tax rates, book-tax differences, and conforming tax avoidance measures) and tax risk (and thus use ETR volatility and tax peak indicators). Second, as proxies of specific tax behavior, such as tax sheltering, are based on the U.S. firms, studies of the outside-the-U.S. markets should either develop their own measures for that behavior or rely on more general tax avoidance prox-ies. Thus, as this dissertation focuses on Swedish firms’ tax behavior, I pri-marily rely on general proxies for corporate tax behavior outcomes. However, when specific measures for personal tax behavior (Papers I and II) and corporate tax strategies (Paper IV) are required, they are developed based on the Swedish regulation and using Swedish data. These approaches are therefore expected to provide a robust view on a multifaceted phenomenon of corporate tax behavior.

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e ou

tcom

es; u

sing

long

er p

erio

d C

ASH

ETR

s also

lim

its th

e lo

ss-y

ear b

iase

s in

esti-

mat

ing

the

exte

nt o

f cor

pora

te ta

x av

oid-

ance

.

Use

limite

d w

hen

exte

nsiv

e lo

ngitu

dina

l dat

a is

not

avai

labl

e or

shor

t- te

rm e

f-fe

cts a

re to

be

eval

uate

d.

Dyr

eng

(200

8),

Rego

and

Wils

on (2

012)

, G

raha

m e

t al.

(201

4)

Ind

ustry

-yea

r ad

just

ed G

AA

P ET

R

GA

AP

ETR,

dem

eane

d

by in

dust

ry-y

ear

Dev

iatio

n fro

m in

dus

try-y

ear a

vera

ges i

s ind

ic-

ativ

e of

abn

orm

al ta

x be

havi

our.

Iden

tific

atio

n of

com

para

-bl

e in

dust

ry p

eers

is n

ot a

l-w

ays

stra

ight

forw

ard

.

Chy

z an

d G

aer

tner

(201

8);

Arm

stro

ng e

t al.

(201

5)

Mea

sure

C

onst

ruct

ion

Mot

ivat

ion

Com

men

ts

Exam

ples

of u

se

Ind

ustry

-yea

r ad

-ju

sted

CA

SH E

TR

CA

SH E

TR, d

emea

ned

by

indu

stry

-yea

r D

evia

tion

from

ind

ustry

-yea

r ave

rage

s is i

n-di

cativ

e of

abn

orm

al ta

x b

ehav

iour

. Id

entif

icat

ion

of c

ompa

ra-

ble

indu

stry

pee

rs is

not

al-

wa

ys st

raig

htfo

rwa

rd.

Chy

z an

d G

aer

tner

(201

8)

Book

-tax

diff

er-

ence

(BTD

) D

iffer

ence

bet

wee

n ex

pect

ed ta

x ex

pens

e,

base

d o

n st

atu

tory

tax

rate

, and

rep

orte

d ta

x ex

pens

e. S

cale

d by

la

gged

ass

ets (

or m

ar-

ket c

apita

lizat

ion,

or

simila

r mea

sure

cap

-tu

ring

firm

size

)

Unlik

e ET

Rs, b

ook-

tax

diff

eren

ces d

irect

ly d

e-sc

ribe

the

tax

avoi

dan

ce e

ffect

rela

tive

to

the

sta

tuto

ry ta

x ra

te. I

t cap

ture

s the

eco

-no

mic

ext

ent o

f tax

avo

idan

ce b

ehav

ior b

et-

ter s

ince

the

mea

sure

is sc

aled

by

a st

abl

e fir

m-le

vel c

hara

cter

istic

, rat

her t

han

rela

tivel

y vo

latil

e pr

e-ta

x in

com

e. Is

dire

ctly

inte

rpre

ta-

ble

for l

oss y

ears

Rele

vant

stat

utor

y ta

x ra

te

is un

clea

r whe

n a

firm

has

in

tern

atio

nal o

pera

tions

. V

aria

tions

may

incl

ude

othe

r tax

item

s, su

ch a

s ca

sh ta

x pa

id, o

f cur

rent

po

rtion

of t

otal

tax

only

.

Mills

(199

8)

Chy

z, G

aertn

er, K

ausa

r an

d W

ats

on (2

018)

TS-S

core

(tax

shel

-te

r) Lik

elih

ood

tha

t a fi

rm is

us

ing

tax

shel

ters

. Est

i-m

ated

usin

g an

em

piri-

cal m

odel

bas

ed o

n ac

tual

tax

shel

terin

g ca

ses

Cer

tain

firm

cha

ract

erist

ics s

erve

as i

ndic

a-to

rs th

at t

he fi

rm m

ay e

nga

ge in

tax

shel

ter-

ing

activ

ity.

U.S.

- bas

ed e

mpi

rical

mod

-el

s, in

tern

atio

nal g

ener

ali-

zabi

lity

ques

tiona

ble.

Wils

on (2

009)

; Lis

owsk

y (2

010)

; Ki

m, L

u, a

nd Z

hang

(201

1);

Rego

and

Wils

on (2

012)

; A

rmst

rong

et a

l. (2

012;

G

raha

m e

t al.

(201

4)

DTA

X (d

iscre

tion-

ary

perm

anen

t BT

D)

Disc

retio

nary

per

ma-

nent

diff

eren

ces.

Esti-

mat

ed a

s res

idua

ls of

a

regr

esss

ion

tha

t elim

i-na

tes n

on-d

istre

tiona

ry

sour

ces o

f per

man

ent

book

-tax

diffe

renc

es

from

the

tota

l per

ma-

nent

diff

eren

ces

Tem

por

ary

book

-tax

diffe

renc

es re

flect

ear

n-in

gs m

anag

emen

t via

pre

-tax

accr

uals.

Be-

caus

e of

the

sam

e re

ason

, sho

rt-te

rm c

ash

ETRs

are

spur

ious

ly re

late

d to

boo

k-ta

x d

iffer

-en

ces.

Tem

por

ary

porti

on o

f tax

avo

idan

ce

thus

nee

ds to

be

elim

inat

ed fr

om th

e ta

x av

oida

nce

mea

sure

.

A m

easu

re b

ased

on

U.S.

se

tting

and

regu

latio

n,

high

ly sp

ecifi

c in

its p

urpo

se

(inve

stig

atio

n of

ass

ocia

tion

betw

een

earn

ings

man

-ag

emen

t and

tax

avoi

d-

ance

). H

owev

er, u

sed

m

ore

broa

dly

in c

iting

stu-

dies

.

Fran

k, L

ynch

, and

Reg

o (2

009)

; Re

go a

nd W

ilson

(201

2)

Mea

sure

C

onst

ruct

ion

Mot

ivat

ion

Com

men

ts

Exam

ples

of u

se

Abn

orm

al B

TD

A p

art o

f boo

k-ta

x d

if-fe

renc

e th

at i

s not

at-

tribu

tabl

e to

ac

coun

ting

accr

uals

Cap

ture

s man

ager

ial d

iscre

tion

unde

r the

hy

poth

esis

that

tax

avoi

danc

e is

used

to

mas

k m

anag

eria

l div

ersio

n.

Dev

elop

ed a

s a p

roxy

for

tax

shel

terin

g ac

tivity

be-

fore

tax

shel

ter m

odel

s w

ere

dev

elop

ed.

Des

ai a

nd D

harm

apal

a (2

009;

200

6); C

hen

et a

l. (2

010)

Con

form

ing

tax

avoi

danc

e

CO

NFT

AX

Estim

ated

as a

par

t of

tota

l tax

bur

den

(tot

al

cash

tax

paid

ove

r to-

tal a

sset

s) th

at i

s not

ex

plai

ned

by n

on-c

on-

form

ing

tax

stra

tegi

es

and

ope

ratin

g pe

rfor-

man

ce

Cer

tain

firm

s (su

ch a

s firm

s sub

ject

to lo

w

capi

tal m

arke

t pre

ssur

es) m

ay c

hoos

e to

re

duc

e th

eir t

ax b

urd

en b

y sim

ulta

neou

sly

redu

cing

thei

r boo

k pe

rform

ance

. Suc

h ta

x av

oida

nce

stra

tegy

is n

ot c

aptu

red

by n

on-

conf

orm

ing

tax

avoi

danc

e m

easu

res.

Econ

omic

sign

ifica

nce

is im

-po

ssib

le to

infe

r.

Des

crib

es b

ehav

ior o

nly

rela

-tiv

e to

pee

rs, n

ot a

des

crip

-tio

n of

abs

olut

e b

ehav

ior.

Bad

erts

cher

et a

l. (2

018)

Tax

risk

Vol

atilit

y of

CA

SH

ETR

Rollin

g vo

latil

ity o

f C

ASH

ETR

Ef

fect

ive

tax

rate

vol

atilit

y re

pres

ents

tax-

re-

late

d u

ncer

tain

ties a

risin

g fro

m fi

rm o

pera

-tio

ns, t

rans

actio

ns, a

nd fi

nanc

ial r

epor

ting

deci

sions

.

May

not

be

rela

ted

to ta

x av

oid

ance

leve

ls (B

loui

n,

2014

); D

yren

g, H

anlo

n,

May

dew

(201

8).

Mea

sure

may

be

dist

orte

d by

lo

ss y

ears

.

Hutc

hens

and

Reg

o (2

015)

; G

uent

her,

Mat

suna

ga,

and

Willi

ams (

2016

)

Mea

sure

C

onst

ruct

ion

Mot

ivat

ion

Com

men

ts

Exam

ples

of u

se

Obs

erve

d an

d pr

edic

ted

settl

e-m

ents

with

Ta

x A

utho

ritie

s

Inst

ance

s of s

ettle

-m

ents

, or C

ASH

ETR

pe

aks

Tax

settl

emen

ts in

dica

te u

nsuc

cess

ful t

ax

avoi

danc

e be

havi

or th

at r

epre

sent

s out

-co

me

unce

rtain

ty to

the

shar

ehol

ders

.

Mor

e lik

ely

to c

aptu

re ta

x ev

asio

n; b

iase

d as

onl

y ca

p-tu

res u

ncov

ered

and

den

ied

ta

x st

rate

gies

.

Baue

r and

Kla

ssen

(201

4);

Saav

edra

(201

3)

Unce

rtain

Tax

Be

nefit

s res

erve

(le

vels

and

addi

-tio

ns)

Unce

rtain

tax

bene

-fit

s (i.e

. cla

ims t

hat

may

not

be

ap-

prov

ed b

y th

e IR

S)

tha

t are

repo

rted

un-

der

FIN

48

Unce

rtain

tax

posit

ions

indi

cate

the

exte

nt o

f ta

x pl

anni

ng a

nd, a

s a p

oole

d m

easu

re, i

s ea

sy to

obs

erve

. Exc

essiv

e UT

Bs m

ay

repr

e-se

nt su

bsta

ntia

l tax

-rela

ted

risk

s as e

vent

ual

tax

outc

ome

is un

know

n at

the

time

of re

-po

rting

.

U.S.

- spe

cific

mea

sure

. Inh

er-

ently

disc

retio

nary

. Ha

nlon

, May

dew

, Sa

a-ve

dra

(201

7); A

rmst

rong

et

al (2

015)

; Hut

chen

s and

Re

go (2

015)

; Dyr

eng,

Ha

nlon

, May

dew

(201

8)


1.4. The Three-Hurdle Corporate Tax Planning Framework

Just as many other corporate processes, tax planning is a complex activity that is simultaneously shaped by a multitude of internal and external factors. Thus, to understand how and why corporate tax planning activities take place in the firm, it is instrumental to have a broader conceptual view not only on what factors affect corporate tax behavior, but also how these factors interact in shaping the outcomes that the public, regulatory bodies, and researchers eventually observe. To that end, I utilize the three-hurdle tax planning frame-work developed by Feller and Schanz (2017). This framework identifies three sequential hurdles of corporate tax planning: availability, desirability, and im-plementability of corporate tax strategies.

The availability of tax planning strategies refers to the regulatory and ob-jective firm level determinants of corporate tax outcomes, such as taxation system in which the firm operates, as well as the complexity, financing, and income structure of the firm. In other words, the hurdle of availability refers to whether business characteristics facilitate or constrain the use of certain tax planning strategies. The second hurdle, the desirability of corporate tax planning, refers to the values and priorities of the firm, including managerial preferences and operational constraints. Finally, the implementability refers to the firm’s ability to actually implement tax planning strategies and relates to the managerial responsibilities and power in the firm. As per this frame-work, for a certain tax planning strategy to be implemented, all three hurdles need to be passed; likewise, the fact that one of the hurdles is jumped over does not mean that tax planning activity will take place, if conditions implicit in the remaining hurdles are not met.

I further review each of these hurdles in more detail and discuss how the findings of previous literature can be viewed through the three-hurdle tax planning framework.

CHAPTER 1 15

Figure 1.1. The three hurdles of tax planning

1.4.1. Hurdle 1: Availability of Tax Planning Opportunities

Whether and what tax planning strategies are available for a firm to a large extent depends on the firm-level characteristics and the regulatory environ-ment of the market(s) that the firm operates in. Previous literature provides ample evidence on how various regulatory principles and initiatives guide tax planning behavior; specific firm-level characteristics, such as size, type of op-erations, or financing structures, are also related to such behavior. The pur-pose of this section is to provide an understanding how these country- and firm-level characteristics shape the availability of tax planning strategies. In this section, I therefore provide an overview of research on several interna-tional reporting principles that guide reporting behavior for tax purposes, and discuss the literature investigating firm-level characteristics related to the availability of certain tax planning strategies.

Adapted from Feller and Schanz (2017)

Hur

dle

1: a

vaila

bilit

y

Hur

dle

2: D

esir

abili

ty

Hur

dle

3: I

mpl

emen

tabi

lity

All conceivable tax planning methods

Available tax planning methods

Desirable tax planning methods

Implemented tax planning methods


1.4.1.1. Tax planning-related regulation

Territorial vs. worldwide taxation system

The broadest regulatory principle related to the tax planning strategies’ avail-ability for a firm with international operations is the territorial vs. worldwide taxation system that is in place in the country of the firm’s incorporation. Under the territorial taxation system, income earned in a specific country is taxed at the local tax rate. In contrast, under the worldwide taxation system, the tax rate of the domicile is applied to all income regardless of where it has been earned, as soon as it is repatriated. Thus, under the worldwide taxation system, whether the firm is able to engage in tax planning is largely dependent on the type and structure of its operations as well as its financial position. For instance, De Simone, Piotroski, and Tomy (2017) show that U.S inter-national firms react to expected repatriation tax deductions by accumulating cash in foreign subsidiaries; and, more generally, firms exposed to repatria-tion taxes tend to avoid repatriation by accumulating cash outside domicile’s jurisdiction (Foley, Hartzell, Titman, & Twite, 2007). In other words, firms that have sufficient financial flexibility may choose to leave their financial resources unemployed so as to reduce their total tax costs, or chose to invest, possibly inefficiently, in jurisdictions where the cash is trapped (Hanlon, Lester, & Verdi, 2015). Overall, when it comes to the availability of tax plan-ning strategies in relation to the type of taxation system, Markle (2016) shows that income shifting activity is lower in firms subject to worldwide income taxation, likely because potential complications related to such activity limit the attractiveness of such tax planning strategy.

Thin capitalization rules

Corporate tax reporting principles typically allow deducting debt interest from taxable income. This provides a loophole via which firms with interna-tional operations can reduce the group-level income tax expense. OECD countries during the recent decades have taken measures to limit such be-havior by introducing thin capitalization rules. Thin capitalization rules, that are now a part of the tax regulation in more than two thirds of the OECD countries (but not Sweden; see Section 1.5.2.), regulate tax avoidance activity by defining how much of the corporate debt, relative to equity, is subject to

CHAPTER 1 17

interest deduction from taxable income. Indeed, research shows that the in-troduction of thin capitalization rules has reduced the use of intra-group fi-nancing structures for tax planning purposes; it has also reduced total leverage of international subsidiaries (Blouin, Huizinga, Laeven, & Nico-dème, 2014; Buettner, Overesch, Schreiber, & Wamser, 2012)1.

Tax enforcement

While tax compliance enforcement is not a regulation in itself, but rather represents country-level ability to effectively implement tax reporting regu-lations, it is a dimension that several studies show to be an important driver of tax planning strategies. Most notably, Dyck and Zingales (2004) and Desai, Dyck, and Zingales (2007) provide evidence that low levels of tax enforce-ment facilitate income diversion that is oftentimes illegal; on the other hand, increasing tax enforcement limits such behavior both in terms of managerial diversion as well as tax evasion. Thus, tax enforcement is a part of the first hurdle of tax planning, as it effectively defines whether possibly illegal tax planning strategies are available to the firm2.

1.4.1.2. Firm-level characteristics and availability of tax planning strategies

Feasibility of tax planning

Basic firm characteristics, such as size and profitability, often define whether tax planning opportunities are even perceived as available by the decision makers in the firm. For relatively small firms, investment in certain tax plan-ning strategies, even when theoretically possible, may not be feasible from

1 In Sweden, rules limiting the size of interest subject to tax deductibility will come into effect in 2019. The maximum amount of deductible interest is set as the higher of SEK 5 mill or 30% of EBITDA (KPMG, 2018). The Swedish rules serve the same goal as thin capitalization rules; that is, corporate ability to shift profits for tax purposes willl be limited by firm performance.

2 Tax enforcement level is only one of the factors defining whether illegal tax plan-ning strategies will be used. As in this dissertation I concentrate on legal (or likely legal), tax planning behavior in a market where tax compliance is high (see Section 1.5.2.) I do not discuss other factors constraining of facilitating tax evasion, and present some evi-dence on tax enforcement effects for illustrative purposes only.


the economic point of view. It is because the implementation costs of tax planning outweigh potential benefits such behavior may yield (Delgado, Fer-nandez-Rodriguez, & Martinez-Arias, 2014). On the other hand, large firms may refrain from certain tax planning methods due to political costs that such activities may entail (Gupta & Newberry, 1997; Zimmerman, 1983). To-gether, such insights suggest a non-linear association between the firm size and the extent of tax planning; such form of the association could also be the reason why early studies on the topic have never reached clear consensus on the relationship between firm size and tax planning approaches (Mills et al., 1998; Siegfried, 1973; Stickney & McGee, 1982).

Corporate performance can also be expected to be related to the extent of tax planning activities since tax planning directly determines what part of profit will be retained in the firm instead of being paid as taxes. Higher prof-itability implies higher present value of future savings arising from tax plan-ning strategies (Delgado et al., 2014). In contrast, firms with low or negative taxable income have very limited use of tax planning strategies and are typi-cally tax-disadvantaged (Henry & Sansing, 2014). Thus, a firm’s perception of what tax planning strategies are available and economically feasible may depend on the current and expected performance of the firm (Kim, McGuire, Savoy, & Wilson, 2018). Indeed, Rego (2003) demonstrates that firms with higher levels of pretax income typically have lower effective tax rates, which supports the notion that firms invest in tax planning more when potential savings are greater.

International operations

As already noted before, firms with international operations can make use of differences in tax regulation across the jurisdictions that they operate in. Ad-mittedly, effective tax rates that are lower than statutory tax rates of the home jurisdiction are sometimes simply a result of the different tax rates that vari-ous parts of the company are subject to. Thus, low level of effective tax rates does not necessarily reflect any active tax planning. However, as commented by Sigbjørn Johnsen, Norway’s former minister of finance, some interna-tional firms have become very efficient in using the regulatory opportunities arising from the differences in international tax rules:

CHAPTER 1 19

“It used to be that we had treaties to stop double taxation, but now we have seen these treaties allow double no-taxation.” (The Guardian, 2013)

The notion that multinational firms actively avoid taxes and the extent of this activity has been increasing over time is supported by numerous studies. For instance, Rego (2003) shows that U.S. firms with international operations pay lower corporate income taxes, and argues that such outcome is the result of the economies of scope (i.e. ability to exploit regulatory differences across jurisdictions). Klassen and Laplante (2012) explicitly investigate changes in income shifting activity of the U.S. multinationals and find that the extent of such behavior has significantly increased over time. Evidence of income shifting strategies is also provided in the European setting (e.g. Dharmapala & Riedel, 2013), and it appears that such behavior strongly affects developing countries in which multinational companies are present (Johannesen, Tørsløv, & Wier, 2016; Otusanya, 2011).

Transfer pricing

Conditional on corporate structure facilitating intra-group transfers, transfer pricing becomes one of the main tools for group tax planning. Typically, transfer pricing is based on an arm’s length principle, which postulates that when “conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly” (Article 9 of the OECD Model Tax Convention (2017)). That is, the prices of the goods or services at which they are transferred within the firm should be comparable to the price at which those goods or services could be sold to or purchased from an independent party.

Literature suggests two main ways in which transfer pricing activities could be used for tax planning purposes: intra-group debt and transactions involving intangible assets.

Intra-group financing structures. Under current regulatory principles, most companies can deduct their interest expense from their taxable income. Such


deductibility has several applications in tax reduction strategies. Should the firm have international subsidiaries, intra-group financing structures may be used to shift profits to jurisdictions with lower statutory tax rates (Bartelsman & Beetsma, 2003). At a more local level, debt financing can also reduce in-vestor tax burden; that is, while dividends would be subject first to corporate, and then personal income tax, debt interest is only subject to personal capital gains tax.

With such regulatory principles in place, it could be expected that higher leverage is associated with higher corporate tax avoidance. Previous research provides support to this notion. For instance, Desai, Foley, and Hines Jr. (2004) show that the use of internal debt is related to the local statutory tax rates of international subsidiaries. Rego (2003) reports that international U.S. firms with higher leverage have lower effective tax rates; this finding is cor-roborated by Dyreng, Hanlon, and Maydew (2008) who show that long term tax avoidance of the U.S. firms is related to higher leverage of those firms. Mills and Newberry (2001) find that the debt levels and taxable income of the U.S. subsidiaries with foreign parents depend on the tax incentives of those parents. They thus suggest that financing structures are used to move income to more favorable tax jurisdictions. Similarly, Walsh and Ryan (1997) find that U.K. firms are frequently financed via their own foreign subsidiar-ies, and that those subsidiaries tend to be located in tax-favored jurisdictions.

Intangible assets. A second way to shift profits to low tax jurisdictions is the transfer of intangible assets, such as intellectual property, R&D invest-ments, and patents. For these types of arrangements, a comparable transac-tion is often hard, if not impossible, to find. Moreover, it is typically the owner that is best informed about the potential value of the asset, whereas the tax authorities and other regulators are subject to the negative side of the information asymmetry. Through intangible asset transactions, future in-come arising from such assets can be shifted to lower corporate income tax jurisdictions, therefore yielding tax savings (Sikka & Willmott, 2010). Indeed, the importance of such strategies for contemporary firms as well as the ina-bility of the regulators to ensure that income is taxed where it is earned has been recently highlighted in The Economist:

CHAPTER 1 21

“The rising importance of intellectual property means that it is almost impossible to pin down where a multinational really makes money. Tech giants like Apple and Amazon stash their intangible capital in havens such as Ireland, and pay too little tax elsewhere. This month (August 2018 – author’s note) it emerged that Amazon’s British subsidiary paid GBP 1.7m (USD 2.2m) in tax last year, on profits of GBP72m and revenues or GBP11.4b. By one recent estimate, close to 40% of multinational profits are shifted to low-tax countries each year.” (The Economist, 2018)

Tax planning opportunities in SMEs

While most of the tax planning activities discussed in this section are primar-ily relevant to large multinationals, small and medium enterprises (SMEs) may also have legal tax planning opportunities. In certain jurisdiction, tax regulation occasionally provides additional incentives for certain types of ex-penses that, in addition to being tax-deductible, also yield extra tax credits. The most well-known example of such tax credits is R&D-related incentives in the U.S.3 (See Hanlon and Heitzman (2010) for a review). Most jurisdic-tions also allow some form of group consolidation for tax purposes, even though firms need to meet certain requirements to be able to apply these rules. Decisions oriented towards such compliance, however, could be seen as a manifestation of active tax planning. As a part of tax planning strategy, firms may rely on shareholder-provided debt financing rather than turning to banks; such an approach can be used to reduce the ultimate tax burden that payouts to shareholders are subject to4. Finally, all firms can use tax de-ferrals which, even if not resulting in tax savings in the long run, do provide opportunities for short-term tax planning. I discuss some Sweden-specific tax planning strategies in the description of the Swedish setting, see Section 1.5.

3 Tax credits are not, however, available to Swedish firms operating locally. 4 Dividends are subject to corporate income tax, and then to capital gains tax at an

individual level. On the other hand, paying interest of shareholder loans allows skipping the corporate income tax (see Section 1.5)


1.4.1.3. Hurdle 1: Empirical implications in taxation research

Many firm-, industry-, or country-level characteristics that define whether and what tax planning strategies are available for the firm are also included as control variables in contemporary studies that aim to explain discretionary, i.e. actively chosen, corporate tax behavior. However, the notion of why these controls included in empirical models differs from the argument out-lined by Feller and Schanz (2017). Typically, it is argued that certain tax out-comes emerge naturally (and passively) from business decisions that have nothing to do with active tax avoidance strategies. The decision to include industry or country fixed effects is therefore a natural one since such classi-fications account for structural differences in corporate tax outcomes. De-sign choices related to firm-level time-varying controls are, on the other hand, less straightforward. For example, international scope of firm opera-tions may naturally yield lower effective tax rates than the statutory tax rate of the domicile; but on the other hand, firms may intentionally structure the reporting of their operations in a manner that reduces their total tax burden. Corporate income tax is thus reduced via the use of tax havens and, at an extreme level, illegal tax shelters (Hanlon & Slemrod, 2009; Olsen & Stekelberg, 2015; Wilson, 2009).

To the extent that most firms do not engage in illegal tax planning and their reporting choices are mainly driven by operational considerations, con-trolling for firm- and market level characteristics allows isolating the discre-tionary dimension of tax planning activity that is driven by Hurdle 2 and Hurdle 3 factors (See Sections 1.4.2. and 1.4.3.). If reasonable suspicion exists that firms plan their taxes using the activities captured by control variables, one can reduce the number of control variables to a minimum and see whether and how the empirical results change. This is the approach explicitly adopted in Dyreng et al. (2010).

Another empirical consideration that emerges from the definition of Hurdle 1, i.e. the prerequisite of availability of corporate tax planning, speaks to the sample selection choices. That is, for any given research question, the sample needs to be relatively homogenous in corporate characteristics related to the availability of corporate tax planning; alternatively, any substantial het-erogeneity needs to be explicitly addressed. Indeed, contemporary literature

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consistently adopts such approaches. Listed firms are not mixed with pri-vately owned SMEs; only firms above a certain level of market capitalization are considered; or firms with foreign operations are explicitly compared against otherwise similar firms with domestic operations only (e.g. Rego, 2003). In other words, sample selection implicitly addresses the first hurdle of the the three-hurdle framework, as all, or at least most firms in the sample, have comparable levels of tax planning availability.

In this dissertation, I follow these approaches both in terms of sample selection and treatment of control variables. In Papers I to III, I only con-sider firms listed on the Stockholm Stock Exchange. These firms thus are subject to the same reporting requirements, comparable levels of public scru-tiny, and typically are complex enough to consider developing explicit tax planning strategies. In paper 4, only Swedish micro firms of size and revenue levels clustered around the mandatory audit thresholds are considered. Fol-lowing the argument that industrial and time differences may yield natural (and passive) variations in observed tax outcomes, I always control for in-dustry and year fixed effects. Finally, under the assumption that investment, financing, and reporting choices are primarily driven by operational rather than tax considerations, I include a spectrum of firm-level controls in all em-pirical models. As discussed by Dyreng et al. (2010), this is a conservative choice that may leave little for the research variables to capture; however, it is also the robust one, particularly then the results of univariate associations and alternative specifications are consistent with the main results.

1.4.2. Hurdle 2: Desirability of Tax Planning

Once firm characteristics make tax planning available for the firm, the next hurdle identified by Feller and Schanz (2017) is that of corporate values and priorities. Corporate values refer to long term notions of what the firm’s business is and how the it should be run; in contrast, corporate priorities refer to short term needs, such as liquidity management, that may influence tax planning decisions in the most immediate future. Certain tax planning strategies that pass Hurdle 1 are thus not used in the firm because they are not in line with the values and priorities of the firm.


Traditionally, engaging in tax avoidance is motivated by shareholder value creation. That is, if the costs of tax avoidance do not exceed the bene-fits of such behavior, tax avoidance creates value to the shareholders (see Graham (2003) for a more detailed review). Recent literature, however, pro-vides a more nuanced view on this link, and suggests that what tax planning behavior is preferred depends on the preferences and incentives of key cor-porate decision makers rather than shareholders. Thus, the decision to en-gage in certain tax planning behavior is made on the expectation of value creation; who the actual recipients of this value are, on the other hand, de-pends on the interest alignment in the firm. As a result, tax avoidance may be used to mask managerial rent extraction when interest alignment is poor. On the other hand, when interest alignment is high, tax planning behavior can be shaped by reputational, either firm- or manager-level, concerns, as well as risk management considerations (Austin & Wilson, 2017; H. Desai, Hogan, & Wilkins, 2006; Dyck & Zingales, 2004; Gallemore, Maydew, & Thornock, 2014; Wilde & Wilson, 2018).

In line with such view on value creation, Feller and Schanz (2017) suggest that corporate values are often guided by the preferences of the main owners and top managers, and the values of middle level management and other employees then adjust accordingly. Such notion is rooted in the upper eche-lons theory (Hambrick & Mason, 1984), and the proposition that top execu-tives influence corporate outcomes by setting the tone at the top. On the other hand, variations in short term tax planning outcomes can be explained by changing corporate priorities, such as financing needs, competitor pres-sures, or peer pressure.

Indeed, taxation literature provides empirical support to these proposi-tions. Evidence exists that ownership structure is related to corporate tax planning strategies. Many studies show that top managers and their prefer-ences can be related to corporate tax outcomes. Finally, literature appears to support the notion that external pressures as well as internal corporate needs influence tax reporting decisions. I further review each of these strands of literature in more detail.

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1.4.2.1. Ownership role in corporate tax planning

Previous literature suggests two ways in which ownership is related to cor-porate tax planning choices. First, different types of owners have varying perferences for corporate tax planning, which is a notion directly articulated by Feller and Schanz (2017). Second, the degree of agency issues arising from ownership structures may direct whether and what kinds of tax planning ap-proaches are acceptable and/or preferred in the firm.

Several studies investigate different types of owners and their influence on corporate tax planning outcomes. Chen, Chen, Cheng, and Shevlin (2010) suggest that listed family-controlled firms engage in less non-conforming tax avoidance as their shareholders consider longer investment horizons and are more concerned about the reputational issues related to potential rent extrac-tion5. In contrast, Cheng, Huang, Li, and Stanfield (2012) show that firms targeted by hedge fund activists demonstrate increases in their corporate tax avoidance levels after the intervention; they also show that such changes are not related to increased tax risk and are positively related to hedge funds’ past experience in corporate tax planning strategies. In other words, hedge funds’ goal of increasing firms’ efficiency directly affects corporate tax out-comes. Consistent with this insight, studies investigating the association be-tween institutional ownership and corporate tax avoidance levels typically suggest positive causal directional effect, primarily because at higher levels of institutional ownership, the managers put more effort in justifying their com-pensation by increasing firm efficiency (Bird & Karolyi, 2016; Khan, Sriniva-san, & Tan, 2016). On the other hand, long-term institutional ownership appears to be negatively related to corporate tax avoidance, since investors with a long-term focus discourage activities that may be related to managerial opportunism and reduced transparency (Khurana & Moser, 2012).

5 Badetscher et al. (2017) also investigate the sample used by Chen et al. (2010) and

demonstrate that while family firms do engage in less non-conforming tax avoidance (which was the original finding), they also engage in more conforming tax avoidance. While such observation dues not contradict the reputational cost argument put forward by Chen et al. (2010), it clearly demonstrates that tax planning can take different forms depending on owners’ preferences.


The question of how agency issues and, specifically, the degree of sepa-ration between ownership and control are related to corporate tax outcomes is explicitly investigated by Badertscher, Katz, and Rego (2013). Using varia-tions in insider ownership, Badertscher et al. (2013) show that concentrated insider ownership is related to lower corporate tax avoidance. They suggest that this is because tax avoidance represents risks that owner-managers, due to their risk aversion, are unwilling to take. McGuire, Wang, and Wilson (2014) investigate how agency issues arising from extreme separation of own-ership and control affect corporate tax behavior. They show that the separa-tion of voting and cash flow rights is associated to lower levels of corporate tax avoidance and argue that such relationship is the result of managerial entrenchment. It thus appears that potentially suboptimal corporate tax be-havior can emerge both when separation between ownership and control is low as well as when it is high.

In the context of the three-hurdle framework (Feller & Schanz, 2017), it is important to note that the degree of separation between ownership and control may direct not only whether, but also what kinds of tax planning strat-egies are desired. In that regard, a useful insight from the literature relating corporate ownership structure and corporate tax behavior is that public and private firms are likely to engage in different types of tax planning. Specifi-cally, in firms where ownership and control are separated, financial reporting is the main mechanism through which the owners are informed about the performance of the firm. Thus, managers are incentivized to report high book performance. However, in privately held firms, the degree of infor-mation asymmetry is likely to be much lower, since owners are much more closely involved with the firm and likely do not rely on official financial re-ports. In such situations, owners’ priorities may suggest tax burden optimi-zation regardless of reported performance outcomes. The owners of privately controlled firms may accept (temporarily) lower reported profit if such reporting choice also means reduced tax burden. First panel data-based evidence of such conforming tax avoidance behavior in private firms is pro-vided by Badertscher, Katz, Rego, and Wilson (2017). Badertscher et al. (2017) thus demonstrate that firms with low capital pressures are more likely to engage in conforming tax avoidance strategies. Such strategies are dis-tinctly different from non-conforming tax avoidance that are captured using

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effective tax rates and accepted measures of tax avoidance and illustrate how corporate ownership-related priorities can guide the choice of tax-induced reporting choices.

In this dissertation, I contribute to this line of research by investigating corporate tax planning in Swedish micro firms, i.e. the firms where the sep-aration between ownership and control is virtually non-existent. In such a setting, it could be expected that the use of non-conforming tax planning strategies is not particularly pronounced for several reasons. First, opportu-nities of such behavior are likely to be limited in micro firms (see Hurdle 1 discussion). Second, owner-managers have inside knowledge of the genuine corporate performance and therefore do not require it to be reflected in for-mal financial statements. Third, conforming tax avoidance is easier to imple-ment, since it primarily involves early expense recognition or deferring income. See the Paper IV summary at the end of this chapter for a more detailed discussion.

1.4.2.2. Managerial preferences and corporate tax planning

The question of whether and how individual managers influence corporate tax outcomes has gained traction after the seminal paper by Dyreng, Hanlon and Maydew (2010) who demonstrate that individual CEOs, CFOs, and other top executives have a systematic idiosyncratic effect on corporate tax behavior. This effect has been shown to be significant both statistically and economically; specifically, moving from the executive in the 25th percentile to the one in 75th percentile would result in approximately 11% decrease in total effective tax rate.

While Dyreng et al. (2010) do not find any evidence that fixed managerial effects can be related to the individual characteristics of those managers, other studies do find associations between managerial characteristics and corporate tax planning outcomes. Chyz (2013) employs stock option back-dating as a proxy for personal tax aggressiveness and documents a positive relationship between the executives’ personal tax aggressiveness and corpo-rate tax avoidance, measured as the tax shelter score and cash effective tax rate. Olsen and Stekelberg (2015) show that CEO narcissism is positively related to the probability of tax shelter use; similarly, Chyz, Gaertner, Kausar and Watson (2018) find that CEO overconfidence is related to cash effective


tax rate, tax shelter score, book-tax differences, and permanent book-tax dif-ferences. Law and Mills (2016) find a negative relationship between CEO integrity, measured as military experience, and effective tax rates. Francis, Hasan, Wu, and Yan (2014) show that female CFOs are typically more tax conservative than their male counterparties. Some studies also demonstrate the relation between political conservatism and corporate tax avoidance (Christensen, Dhaliwal, Boivie, & Graffin, 2014; Francis, Hasan, & Sun, 2012).

A typical question arising in this stream of literature is the direction of the effect; that is, is it the manager that modifies the behavior of the firms in accordance to his own preference, or is it the firm that choses a manager with compatible preferences? The literature tends to lean towards the former explanation, i.e. that managers have discretionary influence over corporate tax outcomes. This is particularly the case when tax-specific personal charac-teristics, such as personal tax aggressiveness, are considered (Chyz, 2013). The reason for this could be that while other personal characteristics can be relatively easily recognized, information about personal tax preferences is typically hard to observe. Moreover, even when it can be observed, it is un-likely to play a major role in executive hiring decisions.

In this dissertation, I extend this stream of literature by investigating whether CEO personal tax preferences can explain the tax behavior of their firms. A unique feature in this study is the measure of personal tax behavior that captures normal, rather than extreme, personal tax behavior manifesta-tions. I find that such CEO personal tax preferences do play a role in ex-plaining corporate tax behavior; that is, I demonstrate that personal tax preferences do not have to be extreme or explicitly articulated to be reflected in corporate tax outcomes. I also show that personal tax preferences of the CEOs are related to both conforming and non-conforming corporate tax avoidance behavior, and that CEOs have a discretionary effect on corporate tax outcomes. See the paper summaries at the end of this chapter for a more detailed discussion.

1.4.2.3. Governance and corporate tax outcomes

Recent literature suggests that tax-related corporate values are also shaped by the board of directors. The board of directors can influence corporate tax

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planning behavior in two primary ways. First, it can improve tax planning efficiency by bringing in additional tax planning knowledge into the firm. Second, corporate boards can block tax planning behavior that is potentially shareholder value-destroying.

Evidence of the first type of link is provided by Brown and Drake (2014) who show that firms with greater board ties to low tax rate firms also have lower tax rates, especially when they both operate in similar business envi-ronment and share the local auditor. Similarly, Brown (2011) demonstrates that a specific tax avoidance strategy, namely the adoption of corporate-owned life insurance shelter, spreads through board interlocks. Finally, Rob-inson, Xue, and Zhang (2012) show that financial expertise in board audit committee is positively related to overall levels of tax avoidance, but nega-tively related to it when tax avoidance is seen as risky.

The findings by Robinson et al. (2012) also serve as evidence that boards limit suboptimal corporate tax aggressiveness by increasing it when it is ar-guably too low and decreasing it when it is arguably too high. This idea is explicitly explored by Armstrong, Blouin, Jagolinzer, and Larcker (2015) who show that that qualified boards mitigate suboptimal high as well as subopti-mal low tax behavior by reducing the former and increasing the latter. Arm-strong et al. (2015) suggest that such associations arise because boards mitigate agency problems that the extreme ends of corporate tax behavior may represent. Finally, some direct evidence of board role in value-creating tax avoidance is provided by Hanlon and Slemrod (2009) who show that when a firm is well governed, news about tax shelter participation on average to not yield any significant stock market reaction. In contrast, this reaction is significant negative for poorly governed firms. That is, it appears that stock market participants perceive high level of governance as preventing value-destroying tax planning activities.

1.4.2.4. External and internal pressures for corporate tax planning

The final set of determinants of tax-related corporate values and priorities reviewed in this chapter covers firm positioning in the market and corporate reactions to perceived market requirements. These determinants include firm goal to meet earnings targets, peer pressure, consumer demands, and reputa-


tional pressures. Depending on their nature, these determinants can be pri-ority-based, thus changing corporate tax behavior in the short run (such as aiming to meet the earnings targets) or ingrained in the core values of the firm (such as taking on societal responsibilities as demanded by the custom-ers).

In line with the notion that short-term constraints affect corporate tax planning behavior, Law and Mills (2015) show that financially constrained firms engage in more tax avoidance, and that this association is particularly pronounced in the presence of unexpected liquidity shocks. Edwards, Schwab, and Shevlin (2015) show that tax planning efforts in the presence of financial constraints are oriented towards a reduction of cash effective tax rates, and do not necessarily influence the total tax expense reported in the financial statements. Thus, even though listed firms may prioritize the opti-mization of the total tax expense over cash tax, such priorities may be easily changed in the presence of financial constraints.

In contrast to financial constraints, a short-term situation where reported tax expense may be prioritized over cash tax is when the firm is pressured to meet or beat earnings targets. Indeed, some evidence exists that firms used their tax reserves to manage earnings (Frank & Rego, 2006; Gleason & Mills, 2008), though this behavior appears to be diminishing following the intro-duction of stricter reporting regulations (Gupta, Laux, & Lynch, 2012).

In addition to capital market pressures, previous research finds that cor-porate tax priorities and values are also affected by firms’ peers, competitors, and clients. Li, Winkelman, and D’Amico (2014) suggest that firms’ tax avoidance behavior may be guided by peer pressure. They find that firms issuing their financial reports simultaneously with their peers engage in more tax avoidance than those that report outside the reporting season and are thus not exposed to direct comparison to their competitors. On the other hand, Cai and Liu (2009) demonstrate that firms operating in competitive environments are more likely to engage in tax avoidance, and this association is particularly pronounced for firms that are at a competitive disadvantage. Relatedly, Kubick, Lynch, Mayberry, and Omer (2014) show that firms tend to mimic the tax planning strategies employed by the market leaders. Finally, Austin and Wilson (2017) show that retail firms with valuable consumer brands, i.e. those firms that are arguably most exposed to consumer reactions

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in response to reputational issues, tend to engage in less corporate tax avoid-ance.

This final question, i.e. whether reputational considerations affect corpo-rate tax planning decisions, has been recently investigated from several dif-ferent angles. In their influential survey study, Graham, Hanlon, Shevlin, and Shroff (2013) suggest that in corporate tax planning choices, corporate rep-utation considerations play an important role. As a result, in the firms where managers are concerned with reputational consequences of tax planning, ef-fective tax rates are higher. Consistent with the results by Austin and Wilson (2017), Hanlon and Slemrod (2009) find that stock markets react negatively to news about tax shelter use in the retail industry. Thus, it appears that many firms do not engage in extreme corporate tax avoidance because of reputa-tional considerations; and those that still do, are at least to some extent pun-ished by the markets. A natural question is then whether executives are also punished for such behavior. Chyz and Gaertner (2018) suggest that they are and show that CEOs in listed U.S. firms are more likely to be dismissed fol-lowing extreme high corporate tax avoidance.

While there is little doubt that corporate tax practices can affect firm’s reputation, the question of whether such changes have any effect on operat-ing performance and shareholder value is still largely open. For instance, when it was revealed in 2012 that Starbucks pays effectively no tax in the U.K., the coffee chain received a lot of negative media exposure, and many calls to boycott the coffee chain were made. A year later, however, the rep-resentatives of the chain insisted that the U.K. operations were unaffected by the scandal. In fact:

“The UK is our fastest-growing market in Europe. Gross profit is up 13 per cent and operating margin is up more than 22 per cent. The loss before tax fell by more than 30 per cent. We are on schedule to open 100 new stores this year and expect the business to continue to grow.” (Spanier, 2014)

A potential explanation for such mismatch may be that customer loyalty does not change after tax-related backlashes, or that the target market is not inter-ested in the tax behavior of the firm. If that were the case, the board of di-rectors, as the ones being able to evaluate firm level consequences of such


reputational issues, are likely to incorporate such considerations in their ex-ecutive hiring/firing decisions.

In this dissertation, I therefore extend the discussion of the executive-level consequences of corporate tax avoidance as I investigate whether CEOs and CFOs are punished for potentially reputation-destroying tax avoidance behavior. This investigation thus allows gaining some insight into whether potential reputational damage also indicates shareholder value damage. The Swedish setting is particularly suitable for this purpose due to the high quality of corporate governance, and because of public opinions that are consistently strictly against tax avoidance at both personal and corporate levels (Edelman, 2012; Schwab & Porter, 2008; Stridh & Wittberg, 2015). Thus, if reputational considerations and public opinions did shape corporate tax planning behav-ior, the link between high corporate tax avoidance levels and executive turn-over should be particularly strong in the Swedish setting. See paper summaries at the end of this chapter for a more detailed discussion.

1.4.3. Hurdle 3: Implementability of Tax Planning Strategies

The final hurdle of tax planning is the implementability of corporate tax strat-egies (Feller and Schanz, 2017). Once the tax planning strategy is available for the firm, and corporate values support the use of such strategy, the ulti-mate question is whether it can be implemented by the corporate tax unit. This question, however, appears to be largely overlooked in the literature, as it is typically, implicitly or explicitly, assumed that if the firm characteristics and corporate values support the use of certain tax planning strategies, such strategies will be universally adopted.

Feller and Schanz (2017) suggest that the implementation of the tax strat-egies is a process that requires a strong position of the tax department. In a situation where the tax unit has tax planning ideas, but does not have suffi-cient levers to implement them, the firm is unlikely to be tax efficient. As one of the tax consultants interviewed by Feller and Schanz (2017) pointed out:

“If you tell a tax director ‘do something to finally lower the ETR’ he will respond ‘how should I do this given that this idiot always says business, business, busi-ness?’ ” (Feller and Schanz, 2017, p 512).

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As per three-hurdle framework, two individuals, the Head of Taxes and the CFO, play the key roles in ensuring the potency of the tax unit. These two actors largely determine how the tax function in the firm looks like and how it can influence corporate tax outcomes. Specifically, Feller and Schanz (2017) identify four sources of the tax unit power:

• internal formal (i.e. size and budget of the unit, financial incentives of the top executives);

• internal informal (access to and relations with top management, rela-tions to other business units);

• external reach and connections (ability to reach out for expert advice and have internal ideas validated);

• capabilities (knowledge and social skills).

While the notions outlined in the three-hurdle framework are intuitively ap-pealing, empirical evidence on the dynamics that fall under the Hurdle 3 of corporate tax planning is limited. This is primarily because information about the tax units and their interactions with other parts of the business is difficult to obtain. Nevertheless, previous literature provides some insight on how incentive structures, internal organizational structures, as well as auditors are related to corporate tax outcomes.

Several studies report associations between executive incentive structures and corporate tax avoidance levels. The pioneering study in this stream of literature is that of Phillips (2003) who shows that compensating business units on an after-tax basis is related to lower corporate effective tax rates. Gaertner (2014) uses a somewhat bigger sample and finds that CEO after-tax incentives are also related to lower effective tax rates, whereas Armstrong, Blouin, and Larcker (2012) show that after-tax incentives of the tax directors are negatively related to GAAP effective tax rates. Finally, Rego and Wilson (2012) demonstrate that CEO and CFO equity risk incentives are positively related to corporate tax avoidance levels. Thus, empirical insights suggest that once executive incentive structures are based on after-tax performance, the tax unit gets more support from the business and thus is better equipped to implement tax planning strategies.

Two studies investigate how internal organization and control are related to corporate tax outcomes. Internal organizational structures are critical to


the effectiveness of the tax unit because they ensure proper information flow and enable the tax unit to ensure corporate tax planning efficiency. Indeed, Bauer (2016) demonstrates that firms with tax-related internal control weak-nesses have approximately 4% higher effective tax rates than firms without such weaknesses. As internal control weaknesses represent a variety of issues ranging from tax unit size to insufficient tax-related expertise, this finding illustrates the importance of the tax unit position in ensuring efficient tax planning outcomes. Gallemore and Labro (2015) demonstrate that the qual-ity of internal information environment is negatively related to effective tax rates. This association is particularly strong in firms with dispersed geograph-ical presence and complex operations. Such insight thus can serve as evi-dence that the availability of tax planning (i.e. international operations and business complexity) does not directly lead to tax avoidance strategies, par-ticularly when tax units do not have sufficient information to implement such strategies efficiently.

Several studies investigate whether and how auditors influence corporate tax planning. As per three-hurdle framework (Feller & Schanz, 2017), audi-tors can be expected to help their clients adopt a desired level of tax planning strategies by sharing their expertise. Accordingly, Klassen, Lisowsky, and Mescall (2015) find that auditor-provided tax services are associated with tax aggressiveness. McGuire et al. (2012) report that auditors that are industry experts help facilitate greater levels of tax avoidance. These results suggest that auditors, as external experts, can assist the internal tax unit in reducing corporate tax burden. Such findings thus speak to the importance of the tax unit’s external reach in improving corporate tax planning.

The three-hurdle framework (Feller & Schanz, 2017) suggests that even if the firm is motivated to engage in tax planning strategies (Hurdle 2), such behavior will not take place if the firm has insufficient ability to engage in such practices (Hurdle 3). Literature provides some empirical evidence on what is likely to happen when such a mismatch occurs. The firm may try engaging in tax planning (tax avoidance), but then may be later challenged by the tax authorities, and, because of incurred tax fines, eventually report high effective tax rates (Hanlon et al., 2013; Saavedra, 2013). The reason behind such an unsuccessful attempt is that the firm in question is not able to suc-cessfully adopt tax avoidance strategies, as it likely does not have sufficiently

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skilled tax executives and advisors (Armstrong et al., 2012; Rego & Wilson, 2012; Robinson, Sikes, & Weaver, 2010). From the empirical point of view, in a cross section of firms, such unsuccessful tax avoiders would be classified as exhibiting little or no tax avoidance, even though it is the outcome, not the behavior or motivation, that is conservative.

Overall, empirical findings reported in previous literature support the notion that the firm’s ability to implement tax planning strategies is crucial if corporate values and priorities are to be reflected in corporate tax outcomes. However, our knowledge about what factors affect the implementability of tax planning is still limited. Thus, two papers in this dissertation aim to ad-dress this gap. In Paper II, I investigate the association between the CFO’s role and corporate tax outcomes. I argue that the tax unit is much more likely to be able to implement firm-level corporate outcomes when it serves under the CFO that perceives tax planning to be an important part of her job and is able to promote tax strategies within the firm. In Paper IV, we investigate whether and how auditors can facilitate corporate tax avoidance in micro firms when the incentive for the auditor to do so increases. See paper sum-maries at the end of this chapter for broader discussion.

1.5. The Swedish Setting

As this dissertation focuses on tax behavior in Swedish firms, in this section, I review the setting in which these firms operate. I structure this section as follows. First, I review the governance environment of the listed Swedish firms. I then review the tax environment in Sweden, and highlight key taxa-tion principles that individuals and firms residing in Sweden are subject to.

1.5.1. Governance in Swedish Listed Firms

Ownership and control structure of the Swedish listed firms has its roots in the first decades of the 20th century, when the so-called German model of financing has been adopted in the Swedish market. Corporate financing was then heavily debt-driven; over time, this meant that corporate control has remained relatively concentrated, even though often it changed hands when


original owners were forced to hand-over their firms to banks as main finan-ciers (Högfeldt, 2005).

Equity financing thus remained of somewhat lower importance until the last decades of the century; however, even with increasing prominence of public equity financing, Swedish stock market can still be described as one with concentrated ownership. Faccio and Lang (2002) estimate that approx-imately 47% of the firms listed at the Stockholm Stock Exchange (SSE) are family controlled, with the names such as Wallenberg, Persson, Stenbeck, Olsson, Lundberg, or Bonnier repeatedly appearing in the lists of voting power holders. Such control is not always directly related to ownership, as the use of control-enhancing mechanisms is widespread across Swedish listed firms. Vural (2017) estimates that, during the period of 2001-2013, over 55% of listed firms (excluding financial firms) used control-enhancing mech-anisms, and this proportion in family-controlled firms was even higher, reaching almost 69%.

The combination of high degree of family control and the widespread use of control enhancing mechanisms may suggest a weak position for mi-nority shareholders, as controlling shareholders may extract rents at the cost of the minority owners. However, this appears to not be the case in the Swe-dish setting. The reason is that cultural and societal norms, such as low level of corruption and crime, openness, and high degree of compliance, serve as informal minority investor protection mechanisms (Dyck & Zingales, 2004; Hogfeldt, 2005). Moreover, corporate control in Sweden is strongly related to social status and reputation, the link that further limits rent extraction or abuse of minority shareholders (Agnblad, Berglöf, Högfeldt, & Svancar, 2001). Reputational considerations are also enhanced by the active role that media plays in providing information about corporate developments and de-cisions to the broad public (Dyck & Zingales, 2002; Sinani, Stafsudd, Thom-sen, Edling, & Randøy, 2008).

Egalitarian values and low power distance in the Swedish society (Hof-stede, 1983) dictate the extent of managerial incentives that previous litera-ture has related to both corporate tax outcomes as well as managerial rent extraction. The CEOs of the Swedish listed firms earn salaries that are sub-stantially lower than those of their U.S. or even European counterparties; the variable part of their compensation is also significantly smaller (Fernandes,

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Ferreira, Matos, & Murphy, 2012). Such compensation structure thus limits the financial motivations for opportunistic executive behavior and incentives for short-term performance management.

In addition to ownership- and norm-driven governance, Swedish listed firms are subject to formal regulation in the form of Swedish Companies Act. The companies are also encouraged to follow the Swedish Corporate Gov-ernance Code. Following this code is not mandatory but is commonly ac-cepted as the standard of good practice. Overall, these formal and informal regulations and pressures create a high quality corporate governance envi-ronment, an outcome which is repeatedly reflected in international govern-ance and competitiveness ratings (Schwab & Porter, 2008; Schwab, 2017).

Overall, thus, the Swedish setting can be described as having the follow-ing characteristics. First, relative to the countries with widespread ownership, capital market pressures on Swedish listed firms are likely lower. Second, concentrated control suggests lower information asymmetry between owners and managers, particularly since controlling entities (families or institutions) often have their representatives sitting at the corporate boards. Third, repu-tational concerns are significant drivers of corporate decisions; and finally, the level of corporate governance, including minority shareholders’ protec-tions, is among the highest of the world.

1.5.2. Tax Environment in Sweden

Sweden can be described as a state with high degree of voluntary tax com-pliance and expectation that everyone contributes their fair share to common welfare. Societal pressure to comply is closely related to trust in the govern-ment which is among the highest in Europe (Edelman, 2012); moreover, the Swedes trust the state more than any other type of legal entities, such as busi-nesses, media, or non-governmental organizations (Edelman, 2012).

The Swedish society also has strong views against hiding income from taxation. According to the survey made by the Swedish Tax Agency in 2012, 78% of the respondents were strictly against misreporting their own income for tax purposes; in a similar survey from 2004, 95% of the respondents dis-agreed with the notion that it is acceptable to evade taxes whenever possible (Stridh & Wittberg, 2015). However, while the society is very critical towards tax evasion, the use of legal tax planning strategies is not discouraged; quite


on the contrary, information about their availability is actively distributed, and even the annual tax filing systems are structured in a manner that helps individuals and small businesses optimize their tax reporting outcomes6.

High levels of corporate governance and strong societal views against tax evasion create a robust setting for the investigation of the drivers behind legal tax planning, which is the main purpose of this dissertation. However, legal tax planning efforts can also take a variety of forms. The purpose of this section is therefore to provide the reader with a broad overview of the envi-ronment in which individual tax payers and businesses make their tax report-ing decisions, and the spectrum of legal tax planning decisions that they may find available.

1.5.2.1. Key elements of personal taxation

Residents of Sweden are subject to labour and capital income taxation. In-come from labour (i.e. salary income and income classified as such) is subject to progressive taxation. Capital income is taxed at a flat rate of 30%. Individ-uals residing in Sweden are subject to Swedish taxation rules regardless of the geographical source of their income.

Taxes on labor

Progressive taxation of labor income is implemented using two mechanisms. First, all individuals are subject to a tax deduction the size of which depends on the gross salary income. Second, taxable salary income is subject to two levels of income tax. All taxable salary income is subject to a municipal in-come tax rate of approximately 32% (the rate varies across municipalities). Taxable income that exceeds a certain size threshold is subject to an addi-tional national income tax of 20 or 25%, depending on the size of gross tax-able income. As a result, direct tax paid on salary income can vary from 0% to approximately 55%. According to the Swedish Tax Agency’s estimates,

6 For example, every year, closely held firms can pay out a certain level of dividends

that are taxed at a preferential tax rate. The Swedish Tax Agency’s tax filing system auto-matically calculates the maximum dividend allowance and explicitly informs the owner of such dividend possibility.

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the average effective tax rate on gross salary income was around 33% in 2006, 27% in 2013, and has been declining since.

Gross salary income also serves as a basis for social contributions that are paid by the employer and are set at 31.42%. While not considered to be taxes per se, these contributions represent a substantial cost to the employer. From the employee’s point of view, this means that the cash salary that an average employee brings home represents around 55% of the total employ-ment costs that the employee is subject to (2013 values). For larger salaries, the after-tax salary may only represent approximately 35% of the total cost.

Taxes on capital

Personal income that arises from various investments and yield dividends, rent, or realized capital gains, is subject to a flat tax rate of 30%. Individuals can fully match realized capital gains and losses up to SEK 100 000 as long as they are reported in the same year; gains and losses that exceed this thresh-old can be matched at 70% rate7. Unmatched realized capital losses cannot be transferred to future reporting periods.

As of 2006, owners of closely held firms are subject to a dividend tax reduction. A certain level of dividends paid to the owners of such firms is taxed at 20%, rather than 30% which is the standard capital income tax rate. A firm is defined as a closely held firm if four or fewer owners (or related owner groups) own more than 50% of the shares, i.e. have control of the company. For these qualifying owners, dividends are taxed at 20% if they do not exceed 2.75 base income levels (a so-called simplification rule, yielding SEK 163 075 in 2017) or if they do not exceed 50% of the total gross salaries paid by the firm8, whichever is larger. Dividends that exceed this value are taxed as salary income. Dividends exceeding 90 base income levels are

7 Since 2012, individuals can also chose to invest via the so-called investment-saving

account (Investerinssparkonto in Swedish) and pay a fixed annual capital income tax that is based on the size of the investment regardless of earned income. This option, however, has not been available during the period covered in Papers I and II, and is therefore not discussed further.

8 Conditional on that the owner or a close relative (spouse, children) has received an annual salary of 6 IBB+5% of all cash salaries in the firm, or 9.6 IBB (557 760 kr in 2017) in that year at that firm.


treated as regular capital income and are taxed at a 30% tax rate. Individuals whole salary income is subject to a high marginal tax rate thus are motivated to reclassify a part of their salary income to capital income; such reclassifica-tion thus yields substantial increases in cash income received by such busi-ness owners.

The purpose of this dividend exemption is twofold. On the one hand, reduced dividend income tax rate is used to promote entrepreneurship and business creation. On the other hand, limits to such dividend payment are aimed at limiting income reclassification from salary to capital income. Such practice was perceived to be widespread before 2006, when these rules came into action. In this dissertation, I consider income reclassification behavior both before the regulation change (Papers I and II), as well as after it (Paper IV).

Tax reporting

Swedish residents that have received income subject to taxation are required to file their annual tax returns until the 2nd of May every year9. The Swedish Tax Agency typically provides preliminary tax returns that are prepared based on the information received from employers, credit institutions, various state institutions, and similar bodies. The responsibility of the individual is there-fore to ensure that the information provided is correct and full; should the individuals have received income that has not yet been reported to the Swe-dish Tax Agency10, it is the responsibility of the tax payer to report this in-come in the tax return.

Failure to file the tax return on time, if such delay has not been approved by the Swedish Tax Agency beforehand, yields an administrative fine be-tween SEK 1 000 – 3 000. Such sum serves as a disciplining factor for an average household since compliance is easy and relatively costless, whereas the cost of non-compliance is well known. On the other hand, for high in-come individuals, such cost does not represent any economically meaningful

9 Exemptions apply; for instance, individuals that have only received capital income,

or individuals that are younger than 18 years and have received income that is not subject to income tax are not required to file their tax returns.

10 E.g. income for services provided through sole proprietorship.

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burden; however, in such cases, failure to report on time (and not communi-cating that in advance) may indicate lax attitudes towards tax compliance.

Misstatements of taxable income also yield administrative fines that vary from 20% to 40% on non-paid tax. Such misstatements arise from three main sources: overlooked/forgotten income information, intentional attempts to misclassify income in an attempt to reduce tax burden, and unintentional misclassification of income. Misstatements are most frequent among individ-uals with complex income and compensation structures, e.g. entrepreneurs and top level managers. One example of such misreporting is intentional or unintentional income underreporting that often occurs in the presence of stock option compensation. This type of income may go unreported when received, as it does not yield any cash flows at that point of time. Upon the sale of the option or stock that has been received as a result of stock option exercises, the income is then classified as capital income, even though at least a part of it should have been classified as labor income. The fact that the Swedish Tax Agency in 2000-2001 has executed a full-scale program to in-vestigate the reporting of stock-option bonus programs in listed Swedish companies well illustrates the extent at which such practices have taken place.

Another relatively frequent income misclassification technique is chan-neling salary income to a personally owned company and paying it out as dividends, thus reducing a total tax burden that the revenue is subject to. During 2000-2005 alone, many executives, including Lars Weiss (then-for-mer CEO of MTG), Jan Stenbeck (then-Chairman of the Board for Tele2), Thomas Jisander (former affiliations with Trustor), and Peter Lindgren (for-mer owner of Cell Ventures) have all lost disputes with the Swedish Tax Agency regarding income reclassification from salary to capital income.

Capturing personal tax behavior in this dissertation

As discussed in the review above, personal corporate tax behavior can take different forms varying from fully legal and benign matching of realized cap-ital gains and losses to (suspected) tax fraud. In this dissertation, I present two personal tax behavior measures that are intended to capture the full spec-trum of such behavior. The first measure captures normal tax behavior likely representing different points in personal tax avoidance continuum: matching of capital gains and losses; income reclassification; delayed tax filing; and tax


filing errors. Another measure captures extreme tax behavior via convictions and suspicions of criminal tax avoidance behavior. Normal personal tax be-havior measure is used in Papers I and II. Extreme personal tax behavior is used in Paper I. In Paper IV, we also separately investigate income reclassi-fication from salary to dividends as means of personal tax burden reduction for small business owners.

1.5.2.2. Key elements of corporate taxation

Sweden positions itself as having a business-friendly tax environment with the corporate income tax rate of 22% which compares favourably to other OECD countries, numerous double-taxation avoidance treaties, and various tax reliefs (Business Sweden, 2015). In this section, I review the key principles of corporate income taxation applicable in Sweden that may be used in active corporate tax planning. This discussion is based on the regulatory principles effective in 2018. Some of these principles have changed over time; thus, when relevant, I also explicitly communicate what rules applied during 1999-2014, which is the period covered in this dissertation (1999-2007 in Papers I to III; 2006-2014 in Paper IV).

Corporate income tax

In 1994, the corporate income tax in Sweden was reduced from 30% to 28%. It has remained at this level until 2009, when it was reduced to 26.3%. In 2013, a further reduction of 4.3% took place, and the corporate income tax rate now stands at 22%. Reductions that took place in 2009 and 2013 fol-lowed global income tax development trends; for instance, in 2000, the OECD corporate income tax average was 32.37%, and has declined to 23.73% in 2018 (OECD, 2018).

Taxation of internationally earned income

Sweden uses a territorial taxation system for groups operating internationally. That is, subsidiaries that earn income abroad are only taxed at the tax rate prevailing in the country of operation. For groups with international opera-tions, this taxation approach automatically creates effective tax rate devia-tions from the statutory tax rate, as different parts of income are taxed at different rates.

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Firms that have foreign branches (as opposed to subsidiaries) are taxed on their worldwide income. That is, all income earned by the group is subject to the Swedish income tax rate. In practice, firms pay corporate income tax abroad and then receive tax credits for all such payments in Sweden. This effectively means that firms that receive income in countries with corporate income tax that is higher than the Swedish one will have their effective tax rate reduced via tax credits; and vice versa, firms with operations in countries where the corporate income tax is lower than the Swedish one with pay the difference in Sweden. Differential tax treatment of subsidiary and branch in-come thus creates tax incentives to choose one organizational form over the other, depending on where international operations take place11.

Debt interest deductibility

Swedish regulation allows full tax deduction of external debt interest. Until 2009, interest paid to associated companies was not subject to any limitations except for the arm’s length principle (OECD Model Tax Convention). Start-ing 2009, interest paid to associated companies became subject to interest-stripping restrictions; a current set of restrictions that came in to action in 2013 stipulates that interest can only be deducted if the receiving company pays at least 10% of income tax on that interest, or if it can be conclusively proven that debt on which this interest is being paid has a commercial pur-pose (pwc, 2018a).

Companies in Sweden are not subject to any thin capitalization rules reg-ulating the maximum debt levels for which interest is tax deductible. How-ever, an alternative approach to limiting income tax base erosion is scheduled to come into effect in 2019. Under the new regulation, the maximum tax-deductible interest expense will be capped at the larger of either 30% of EBITDA, or SEK 5 million. To compensate for increasing tax expense, the corporate income tax is planned to be reduced to 20.6% in 2021. This pro-

11 Anecdotal evidence, however, suggests that operational considerations, such as

regulatory environment, planned business sale, and type of transactions that a business engages in play a key role in determining business structure.


posed amendment follows the European Union Anti-Tax Avoidance Di-rective as well as the OECD’s recommendation regarding limitations of base erosion and profit shifting (BEPS) (OECD, 2013; Pwc, 2018c).

As discussed before, intragroup debt interest deductibility allows reduc-ing the group-level corporate income tax by moving part of the taxable in-come to a lower tax rate jurisdiction. Such strategy is thus directly reflected in lower effective tax rates (or higher book-tax differences)12. For individual investors, external debt interest deduction rule also creates opportunities for tax burden reduction. This is because debt interest is paid out of pre-tax in-come and at the recipient level is taxed as capital income. On the other hand, dividends are paid out of net income, i.e. such payment is subject to both corporate income tax and capital gains tax at the individual level. Thus, in-terest payment effectively saves the investors the corporate income tax. Such tax reduction approach, however, is not reflected in effective income tax rates or book-tax differences. Rather, this strategy can be seen as one reduc-ing both book and taxable income, i.e. conforming tax avoidance.

Group contributions

While firms operating in Sweden are not taxed on a consolidated basis, cer-tain business groups can transfer operating losses from one group entity to another by way of group contributions. The standard requirement for such transfer is that the holdings in subsidiaries subject to the group contribution are greater than 90%. This rule is primarily oriented towards groups operat-ing in Sweden, but certain exceptions apply to foreign subsidiaries and par-ents (Pwc, 2018b; Terenius Jilken, 2013).

This regulation has two main implications. First, it effectively allows at least partial consolidation for tax purposes, which yields more efficient tax outcomes for the group13. Second, it creates some possibilities for interna-tional groups to reduce tax burden by shifting losses across jurisdictions.

12 Notably, intra-group debt is not reflected in debt reported in consolidated financial

statements. 13 Consider a group where one fully owned subsidiary is making losses and group

contributions are not allowed. Should this subsidiary at some point become profitable, accumulated losses could be matched against earned profit and tax payable thus would be reduced, if not eliminated; in the long run, total effective tax rate would be close to a

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Such behavior, however, is against the original intent of the regulation, and is highly limited. Nevertheless, in certain cases, firms even go to court for the possibility of international tax consolidation. For instance, in mid-2000s, Lin-dex argued that then-relevant group contribution rules were in conflict with the EU freedom of establishment and were eventually allowed to offset the losses incurred in Germany against the Swedish profits (Parkrud, 2005).

Tax loss carry-forwards

In Sweden, tax losses can be carried forward for an unlimited period of time. However, the use of such carry-forwards is limited upon ownership changes and other substantial reorganizations. The use of tax loss carry-forwards re-duces the cash tax paid in the period when it is used. Total tax expense re-ported in the financial statements, however, is unaffected by such tax reduction.

Allocations to untaxed reserves

Tax loss carry-backs are not allowed in Sweden. However, all Swedish firms are allowed to use a tax deferral strategy that can be seen as similar to tax loss carry-backs. Every year, a firm can allocate up to 25% of its pre-tax profit to untaxed reserves (Böhlmark, 2013). This part of pre-tax income is therefore not subject to corporate income tax in that reporting period. However, it has to be reversed in the 6th year after such allocation at the latest, and then taxed at the prevailing income tax rate. The primary intended goal of such allocation is to match future losses with current profit, and smoothe reported taxable income.

Allocations to untaxed reserves thus represent a tax deferral strategy. In consolidated financial statements, such deferrals constitute a part of a de-ferred tax expense. That is, while this strategy reduces cash tax paid for that period, total reported tax expense is unaffected. However, this strategy can

statutory tax rate. However, should such subsidiary never become profitable and eventu-ally be closed down, this would represent lost tax loss carry-forwards for the group. In the presence of group contributions, losses can be offset in the same period when they occur, thus reducing the tax burden immediately and increasing tax reporting efficiency.


be used to permanently reduce tax payments when corporate income tax re-ductions are expected. When allocations to untaxed reserves are reversed, they are taxed at a rate prevailing in that period. Thus, such deferral can result in permanent tax savings should recognition of pre-tax income be moved to future periods with lower corporate income tax rate.

Other tax deferral strategies

As is the case in most jurisdictions, Swedish regulation allows for different depreciation and amortisation patterns for financial and tax reporting pur-poses. Thus, accelerated depreciation for tax purposes can yield temporary cash tax savings. Total tax expense is typically unaffected by differences in depreciation/amortization patterns.

Capturing corporate tax planning outcomes in this dissertation

As is the case with most countries, Swedish firms are subject to tax rules that differ from the U.S. regulations under which most of corporate tax research takes place. However, despite certain differences, these reporting principles yield the same set of broad tax planning outcomes. That is, firms subject to capital market pressures may be motivated to report higher pre-tax (book) income than taxable income, thus yielding non-conforming tax avoidance. Alternatively, firms may opt for tax burden reduction by supressing both pre-tax (book) and taxable income, behavior that is referred to as conforming tax avoidance. Further, variations in corporate tax expense and payment out-comes, as well as settlements with tax authorities, can also be interpreted in a similar manner as the measures constructed using the U.S. data. In Table 1.2, I provide an overview of how Swedish tax-related reporting choices map into different types of broad tax planning outcomes captured by broad tax behavior measures. I further use these general measures throughout the dis-sertation.

Some questions raised in this dissertation, however, cannot be answered using broad measures of tax planning outcomes. Thus, in Paper IV, we use two measures that are unique to a Swedish setting. The first measure captures mandatory reversals of untaxed reserves, i.e. the reversals that likely occur in the 6th year after the tax reserve formation. This unique regulation creates a semi-external cash tax shock, which we utilize to observe corporate reporting

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behavior changes around anticipated spikes of cash tax payment. The second measure captures the volatility on net allocations to untaxed reserves. As ETR volatility, volatility in untaxed reserves at least to some extent represents tax risk. We thus use changes in this measure as a proxy of sophistication in corporate tax planning behavior.

Table 1.2. Corporate tax behavior classification

Non-conforming tax avoidance

Conforming tax avoidance

Tax risk

Intra-company debt interest X

Shareholder debt interest X

Allocations to untaxed reserves X X

Tax loss carry-forwards X

Group contributions X

Differences in depreciation/amor-tization patterns for book and tax reporting

X

Choice of organizational structure for international operations

X


1.6. Papers – Extended Summaries

In this section, I present extended summaries of the papers that comprise this dissertation. Two broad assumptions underlie these papers. The first one is that on average, more corporate tax avoidance is preferred by the share-holders. As discussed in Section 1.5, Sweden’s corporate landscape can be described as one with high quality of corporate governance (Schwab & Por-ter, 2008; Schwab, 2017); thus, it is not likely that tax avoidance strategies are used to mask rent extraction or managerial diversion. For the same reason, this setting is also suitable for the investigation of the alternative proposition, i.e. that high tax avoidance yields reputational costs (See Paper III). That is, the Swedish setting allows disentangling shareholder and board concerns re-lated to value creation and reputation.

The second broad assumption is that firms prefer lower levels of tax risk. As reasons behind tax outcome variation are typically difficult to observe (in case of ad hoc tax saving opportunities) or represent downside risk (in case of disputes with tax authorities), neither of these two alternatives are expected to be positively perceived by the investors.

Both assumptions are closely connected to the design choices made in this dissertation. I thus concentrate on legal corporate tax planning behavior and use data from a high-quality governance setting. As a result, rather than indicating illegal tax behavior, variations in corporate tax outcomes are likely to reflect various internal and external factors affecting corporate tax plan-ning processes. The papers discussed below investigate such non-financial factors.

1.6.1. Paper I: CEO Personal and Corporate Tax Avoidance Consistency

In this study, we investigate how Swedish CEOs’ normal and extreme per-sonal tax behavior is related to the tax avoidance in their firms. The sample used in this study covers firms listed on the OMX Stockholm Stock Ex-change during 1999-2007.

This study builds on two key insights from the previous literature. First, it relies on Hambrick and Mason’s (1984) upper echelons theory which sug-gests that executives have their individual and unique styles, and that their

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preferences affects various corporate outcomes. Second, this study adopts the psychological proposition that individuals’ behavior in one situation pre-dicts their behavior in another comparable situation (Cronqvist, Makhija, & Yonker, 2012; Funder & Colvin, 1991; Mischel & Shoda, 1995). We therefore predict that CEOs’ personal tax behavior is related to the tax behavior of their firms.

To capture CEOs’ personal tax behavior, we develop measures that are based on information provided in these executives’ personal tax filings (for normal tax behavior) and the information provided by the Swedish National Council for Crime Prevention (for extreme tax behavior). We capture normal personal tax behavior as manifestations of the following types of behavior: matching of capital gains and losses; income reclassification; late tax filings; and errors in tax filings. We capture extreme personal tax behavior as suspi-cions/convictions of tax evasion. Together, these measures capture a full spectrum of personal tax behavior, ranging from absence of active tax plan-ning to tax fraud.

The two main ways in which firms may engage in income tax expense reduction are non-conforming and conforming tax avoidance. We investigate both of them in this study. To capture non-conforming tax avoidance, we adopt a set of book-tax difference-based measures as well as GAAP (total), current, and cash effective tax rates. To capture the extent of conforming tax avoidance, we adopt the model developed by Badertscher et al. (2017).

The empirical findings of this study can be summarized as follows. First, we validate our measures of personal tax behavior. We show that these measures are significantly related to personal risk propensity, personal ethics, financial incentives, and awareness of tax planning opportunities and risks, i.e. the traits that previous literature has identified as drivers of personal tax planning behavior.

Second, we find that CEOs’ normal personal tax avoidance is signifi-cantly related to the corporate tax avoidance of their firms. In contrast, CEOs’ extreme personal tax avoidance is only significantly related to the ex-treme manifestations of corporate tax avoidance. These findings are thus in line with the behavioral consistency proposition that individuals behave comparably in comparable situations, and that normal, rather than extreme,


personal tax behavior should be significantly related to normal corporate tax behavior.

The final question that we investigate in this study is the mechanism through which the association between CEO personal and corporate tax be-havior consistency arises. We investigate three alternative explanations of this association. First, CEOs may be matched with firms based on their tax be-havior. Second, CEOs may be intentionally selected based on their personal tax behavior in anticipation of changing corporate tax behavior accordingly. Third, CEOs may have a discretionary imprint on corporate tax outcomes that has been not been foreseen when the hiring decision was made. Our evidence suggests that the association between CEO personal and corporate tax avoidance behavior is primarily driven by the CEO discretionary imprint on corporate tax behavior.

We offer three main contributions to the corporate tax literature. First, we develop direct measures that capture the multifaceted nature of personal tax behavior. Unlike measures used in previous literature, our personal tax behavior measures are not unique to the United States and are not dependent on corporate affiliations, thus making insights reported in this study more generalizable. Second, we investigate a broad spectrum of personal tax be-havior rather than extreme tax behavior manifestations and show that CEO normal tax behavior explains corporate tax avoidance outcomes better. Fi-nally, we also are the first to examine whether CEOs’ personal tax behavior preferences are consistently related to both non-conforming and conforming corporate tax avoidance strategies.

1.6.2. Paper II: CFO’s Role and Corporate Tax Outcomes

In this study, I investigate how the CFO’s role is related to corporate tax outcomes. The sample used in this study covers firms listed on the OMX Stockholm Stock Exchange during 1999-2007.

This study is motivated by two insights. First, implementation of tax planning strategies often requires changes in the structure of corporate unit reporting and operations; a tax manager may find it a challenge to implement such changes alone (Feller & Schanz, 2017). Thus, CFO’s willingness and ability to promote and enforce such changes is paramount for the success of the tax planning initiatives. Second, during the recent decades, the CFO’s

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role has been undergoing significant developments; such developments in-troduced substantial variations in the CFO’s role as defined within the firm (Ernst & Young, 2008). How these variations relate to corporate tax planning outcomes is, however, still not known. The goal of this paper is thus to in-vestigate how different CFO’s roles relate to corporate tax outcomes.

I define the CFO’s role in the firm as a combination of the functional scope and power of this executive. I capture CFO’s functional scope through the formal CFO titles as communicated in the annual reports or corporate news releases. I classify these titles as generalist CFOs (i.e. the CFO’s func-tion covers finance and non-finance responsibilities) or specialist CFOs (i.e. the CFO’s function covers the responsibilities within financial reporting and management only). To capture the CFO’s power, I use the ratio of the CFO and CEO compensation, adjusted for potential CEO’s ownership biases. This approach directly follows the stream of literature that uses CEO’s pay slice and CEO’s ownership as measures of CEO’s power (Bebchuk, Cremers, & Peyer, 2011; Chintrakarn, Jiraporn, & Singh, 2014). Such classifica-tionsthus yields 4 distinct types of CFO’s role investigated in this study (see Table 1.3).

Table 1.3. CFO’s role distribution across firm-years

CFO specialist CFO generalist

Low power N= 880 (50.4%) N= 156 (8.9%)

High power N= 526 (30.1%) N= 183 (10.5%)

Numbers (percentages) represent the number of observations (percentage of the full sample) with a specific CFO’s role category.

I consider non-conforming tax avoidance and corporate tax risk as two di-mensions of corporate tax outcomes that are likely to be related to CFO’s role. To capture non-conforming tax avoidance, I use a set of book-tax dif-ference-based measures. To capture tax risk, I employ the 3-year volatility of cash effective tax rates (as proxy for uncertainty) as well as cash tax peaks (as proxy for lost tax disputes).


The findings of this study are as follows. First, I validate the CFO’s func-tional scope (specialist vs. generalist) classification by demonstrating that specialist CFOs are more likely to have auditor qualification, are more likely to be female, and earn on average less than their generalist counterparts. These observations are thus in line with the findings of previous literature that specialist CFOs are more likely to have functional (as opposed to broader managerial) background, that females are more likely to be directed to functional career tracks, and that specialist CFOs earn less because they create less value to the firm than generalist CFOs. I also show that firms tend to keep the same type of CFO’s function upon CFO’s change, and CFOs moving to other firms typically move to the same type of function. Such patterns suggest that functional classification of the CFO’s role conveys in-formation about the CFO’s job requirements.

I then demonstrate that the CFO’s role is indeed related to corporate tax outcomes. Specifically, the level of corporate tax avoidance is negatively re-lated to CFO’s role as a specialist when CFO’s power is low, but positively related to it when CFO’s power is high. I suggest that these differences in the direction of association arise from differing CFO’s priorities at different power levels. That is, when CFO’s power is low, generalist CFOs can achieve higher levels of corporate tax avoidance than specialist CFOs due to their broader spectrum of activities and informal reach within the firm. On the other hand, when CFO’s power is high, both types of CFOs have sufficient influence in the firm, but the job demands of the specialist CFOs allow them to prioritize tax planning better. Finally, the results suggest that corporate tax risk is lower in firms with specialist CFOs, and even more so when CFOs have high power. Thus, firms with high power specialist CFOs appear to have highest levels of (legal) tax avoidance and lowest levels of tax risk.

I also find some evidence that the CFO’s role and CEO’s preferences can function as substitutes in achieving (arguably) optimal corporate tax be-havior. When CFO’s power is low, CEO’s personal tax preferences are more strongly related to corporate tax avoidance levels when CFO is a specialist. This suggests that in firms with concentrated, low power CFO’s role it is the CEO, rather than the CFO, that determines the strategic financial direction of the firm, thus partially replacing the function of a CFO. These findings

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thus also extend the understanding of how CEO personal tax preferences are related to corporate tax outcomes (see Paper I).

Finally, an obvious concern in this study is that the association between the CFO’s role and corporate tax outcomes is endogenous. That is, the CFO’s role and corporate tax behavior can be jointly determined by some other (unobservable or unaccounted-for) firm level characteristics. To ad-dress this concern, I investigate individual CFOs moving across firms and their discretionary impact on corporate tax avoidance. Since such individuals typically move to the same type of role, the estimates of their discretionary effect can be used to separate the CFO’s role effect from other firm level characteristics. The findings in this analysis reveal that individuals serving as high power specialist CFOs also have highest discretionary effect on corpo-rate tax avoidance, which is consistent with the main findings reported in this study.

I offer two main contributions to the corporate taxation literature. First, this study is the first one to directly investigate how the CFO’s role relates to corporate tax outcomes. In that regard, I provide some insight on how or-ganizational structures facilitate the implementation of tax planning strategies (i.e jumping over the third hurdle of tax planning process, see Feller and Schanz (2017) as well as Section 1.4.3.) Second, I contribute to the managerial effects studies as I investigate the interplay between CEO’s personal tax pref-erences and the CFO’s role. A notable finding is that the CFO’s role and CEO’s personal preferences may function as substitutes in ensuring that tax behavior of the firm is in accordance with shareholder preferences. I there-fore directly respond to a recent call for research on the interdependencies between individual executives in the firm (Plöckinger, Aschauer, Hiebl, & Rohatschek, 2016).

1.6.3. Paper III: Corporate Tax Outcomes and Executive Turnover: Evidence from Sweden

In this study, I examine whether and how corporate tax outcomes are related to various types of CEO and CFO turnover in listed Swedish firms during 2000-2007. Two main questions that this study aims to shed some light on are as follows: which executive, a CEO or a CFO, do boards perceive to be


responsible for corporate tax outcomes? And what corporate tax outcomes do boards prefer?

The upper echelons theory (Hambrick & Mason, 1984) asserts that top executives influence a variety of corporate outcomes by setting the tone at the top. Tax planning activities, however, require specific legal expertise that most top executives, and particularly CEOs, are unlikely to have. As a con-sequence, they may rely on CFOs, and their teams of internal and external tax specialists, in corporate tax planning. It is thus not obvious whether boards perceive CEOs as the ones primarily responsible for the performance of the tax function, even though previous literature relates corporate tax out-comes to forced CEO turnover (Chyz & Gaertner, 2018). Rather, it could be expected that in the top executive team, the CFO, as responsible for corpo-rate reporting, would be perceived as accountable for tax planning outcomes.

Previous literature suggests that neither extreme low nor extreme high levels of tax avoidance are desired in the firm. Extreme high tax avoidance may be reputation-destroying and therefore have negative shareholder value consequences due to client and market reactions (Austin & Wilson, 2017; Graham et al., 2014; Hanlon & Slemrod, 2009). On the other hand, too low corporate tax avoidance levels suggest foregone shareholder value opportu-nities, and therefore are also not desired (e.g. Chen et al., 2010; Cheng et al., 2012; Chyz & Gaertner, 2018). Finally, tax risk appears to be viewed nega-tively both by the markets and corporate boards, likely because of infor-mation asymmetries and risk of lost tax disputes (Brown, Drake, & Martin, 2016; Guenther et al., 2016; Hanlon, Kelley Laplante, & Shevlin, 2005).

I investigate executive turnovers because turnovers represent an extreme and objectively observable manifestation of board decisions related to exec-utive performance. Forced executive turnover represents an extreme board punishment for unsatisfactory performance. In contrast, external promo-tions likely represent a career reward, as external boards recruit executives based on their observed performance at the old firm. Thus, if boards perceive certain types of tax behavior as desirable or value-destroying, such percep-tion should be reflected in executive turnover decisions.

In empirical investigations, I use hand-collected information about CEO and CFO turnovers in Swedish listed firms during 2000-2007. Based on com-

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municated turnover reasons and further career developments of the depart-ing executives, I classify turnovers as hostile/neutral (i.e. likely hostile) or voluntary; for CFOs specifically, I also identify a set of turnovers that can be classified as external promotions, i.e. turnovers when an executive immedi-ately moves to a better external position. Using this classification, I investi-gate whether different types of CEO and CFO turnovers can be related to preceding corporate tax outcomes. To provide a more nuanced understand-ing of executive career consequences, I also investigate executive compensa-tion which likely represents an internal reward for corporate performance.

The empirical findings of this study can be summarized as follows. First, I find consistent evidence that executives are punished for extreme low tax avoidance levels. That is, forced CEO turnover is positively related to ex-treme low corporate tax avoidance; the probability of CEO turnovers in-creases by anywhere between 29% and 45% following extreme low levels of tax avoidance. I also show that CEO and CFO compensation levels are neg-atively related to low levels of tax avoidance. These findings are therefore consistent to the foregone shareholder value creation opportunities argu-ment.

I find only very limited evidence that extreme high tax avoidance levels are related to executive turnover. First, I find that extreme high levels of tax avoidance are related to voluntary CFO turnovers and, even more strongly, to CFO promotions. Second, I find that extreme high tax avoidance is posi-tively related to CEO compensation. Thus, the evidence suggests that in a Swedish setting, extreme high tax avoidance does not represent reputational costs that board would perceive as significant enough for he executives to be disciplined for.

Finally, I find that the association between forced executive turnover and tax risk is positive, and the peaks in cash effective tax rates (i.e. likely tax settlements) increase the probability of hostile CEO turnover by approxi-mately 42%. I also observe that the association between executive compen-sation and tax risk is negative. These findings therefore provide support to the prediction that boards prefer lower levels of tax risk.

With this study, I propose several contributions to the executive turnover and corporate tax planning literature. First, I investigate two dimensions of corporate tax behavior and empirically show that in a high-quality corporate


governance environment, boards prefer high levels of tax avoidance and low levels of tax risks. Second, the results suggest that boards appear to perceive CEOs, and not CFOs, as primarily responsible for corporate tax outcomes. Third, the findings reported in this study suggest that CEOs and CFOs face asymmetric payoff structures related to corporate tax avoidance. That is, forced/neutral CEO departure is related to low levels of tax avoidance, whereas CFO promotions are preceded by high levels of tax avoidance. Fi-nally, the results of this study highlight the importance of differentiating be-tween voluntary and forced turnovers, as these two types of outcomes likely represent two extreme ends of executive career consequences.

1.6.4. Paper IV: Auditors and Tax Avoidance in Micro Firms

In this paper, we investigate the role that auditors play in small private firms’ tax behavior. To that end, we utilize a 2010 Swedish regulation change that allowed smallest private firms to opt out of audit. This regulation change thus represented a demand shock for the audit industry, as the demand for man-datory audit has shrunk significantly.

We expect audit firms to respond to this increase in competition by tak-ing steps to add additional value for their clients and to differentiate their firm from other audit firms. Previous literature asserts that in small private firms, tax considerations play an important role in financial reporting deci-sions (Ball & Shivakumar, 2005). As such, we hypothesize that the shift from mandatory to voluntary audit regime is associated with an increase in corpo-rate tax planning activities.

To empirically test this prediction, we use a matched sample of firms subject to voluntary and mandatory audit. The sample period is 2006-2014. We conduct differences-in-differences analysis to estimate the effects of re-moving the mandatory audit requirement on these firms’ tax avoidance be-havior. In small private firms, the possibilities of non-conforming tax avoidance are limited. However, such firms typically experience limited ex-ternal reporting pressures; thus, it could be expected that conforming tax avoidance strategies would be considered a viable option in such firms. Fol-lowing these insights, in our empirical investigations, we use a set of tax avoidance behavior measures that capture total tax burden, non-conforming tax avoidance behavior, and conforming tax avoidance behavior.

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Our main results show that following the audit regulation change, firms that voluntarily continued to have their financial statements audited exhibited increases in conforming and nonconforming tax avoidance levels relative to a matched sample of firms that were subject to mandatory audit. This effect is also stronger in low cash use intensity industries, i.e. when firms’ ability to simply misreport is lower, and thus reliance on legal tax planning strategies is higher.

To understand whether such changes have indeed been the result of au-ditors’ efforts to retain their clients, we investigate several specific tax plan-ning strategies that are relatively easy to implement but require certain knowledge and sophistication that auditors are expected to have, but their clients likely lack. Thus, we investigate corporate reporting behavior around forced reversals of untaxed reserves, income reclassification from salaries to dividends, and volatility of net allocations to untaxed reserves. We expect that when auditors provide additional tax advice, firms manage their reported operating performance to amortize the tax payment shock; that owner-man-agers pay out more dividends relative to salaries; and that the volatility of net allocations to untaxed reserves decreases. Our empirical results are in line with these expectations, thus supporting the proposition that corporate tax avoidance increases in voluntary audit firms after the audit regulation change are at least to some extent a result of auditors’ efforts to retain their clients.

The key contributions of this study are as follows. First, we show that auditors, that are expected to function as monitors of reporting behavior, can also be induced to function as facilitators of legal tax avoidance. Second, we provide evidence of preferred tax behavior in firms in which owners are also managers (i.e. agency issues are nearly non-existent), and which face only limited capital market pressures. We thus demonstrate that such firms prefer tax savings over reported performance figures. Overall, we show that regu-latiory changes intended to remove administrative burden for private firms de facto increase the market of tax advisory services.


1.7. Concluding Comments

In this dissertation, I investigate how non-financial factors shape observed corporate tax behavior. In different parts of the dissertation, I concentrate on CEO personal preferences, CFO’s role, boards’ perceptions of desired tax outcomes, and auditor assistance as factors shaping corporate tax out-comes.

Within the three-hurdle framework of tax planning (Feller & Schanz, 2017), the findings of this dissertation enhance the understanding about what shapes the desirability of tax planning (Hurdle 2), and how implementation of desired tax behavior is facilitated or contrained (Hurdle 3). The Swedish setting used in this dissertation allows for a robust investigation of these is-sues in an environment as the empirical results are less likely to be con-founded by managerial rent extraction problems or frequent instances of illegal tax behavior.

This dissertation thus shows how CEOs and boards shape corporate val-ues, which represent the second hurdle in the three-hurdle tax planning framework. It appears that CEO personal tax preferences influence corpo-rate tax avoidance levels. The results reported in this dissertation also suggest that in Swedish listed firms, corporate boards prefer high levels of tax avoid-ance and low levels of tax risk, and such preferences shape corporate tax values based on which executives are evaluated.

This dissertation also provides two insights about what facilitates or con-strains the implementation of corporate tax planning (Hurdle 3). First, the levels of corporate tax avoidance and tax risk appear to be related to the type of the CFO’s role observed in the firm. That is, the implementation of tax planning strategies is dependent on CFO ability and willingness to promote corporate tax planning within the firm. Second, the results of this dissertation provide some evidence on auditor role in corporate tax planning. Specifically, the findings suggest auditors may facilitate corporate tax planning when they are motivated to do so.

As a result, this dissertation has several governance and regulation-re-lated implications. The findings reported in this dissertation show how the choice of the CEO may shape corporate tax outcomes; similarly, they pro-vide some insight as to how different types of the CFO’s role are related to

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the importance of tax planning processes in the firm. Finally, the findings reported in this dissertation show how regulatory changes oriented at admin-istrative burden reductions may have unexpected tax behavior-related con-sequences.

1.7.1. Limitations

As is the case with any archival empirical study, this dissertation has several limitations. First, the data selected for this dissertation allows observing tax outcomes. However, outcomes may not always reflect the preferences or ef-forts of the firm. For instance, consider the firm that is be theoretically able and willing to adopt certain levels of tax avoidance, but attempted implemen-tation of tax planning strategies is not successful. At the outcome level, this firm would be identified as a conservative one, even though from the behav-ior point of view it actively tries to reduce its tax burden (Saavedra, 2013). For this reason, this dissertation does not attempt to identify what type of tax behavior the firm engages in; rather, it investigates what tax outcomes the firm eventually ends up with.

Second, a standard problem in archival studies is the sample period choice. In light of increasing attention to corporate tax planning both from the society and the regulators, the behavior of the firms may be significantly, and rapidly, changing. Studies that use historical data may not be able to cap-ture such developments. The nature of the questions investigated in this dis-sertation limits the risk that the observed associations have changed after the end of the sample period. However, such possibility should always be had in mind, particularly since the sample period in Papers I, II, and III ends in 2007.

Third, empirically establishing the causality and ensuring that empirically observed associations do not arise due to spurious correlations or an unob-served variable bias is a challenge to many empirical studies. This dissertation is not an exception. The question of omitted variable bias is particularly rel-evant in Paper II, where I investigate how the CFO’s role is related to cor-porate tax outcomes, even though methodological choices made in this study at least partially address this issue.

Finally, this dissertation concentrates on legal corporate tax planning. This choice builds on the assumption that observed tax outcomes are in line


with the tax code, either because the firms were compliant to begin with, of their non-compliant behavior was identified and corrected. However, it is important to acknowledge the possibility that some non-compliant firms are not identified and thus their reported tax outcomes also include a certain dimension of tax evasion. If that is the case, then the associations reported in this study may also to some extent explain illegal tax avoidance behavior. However, given data limitations, the question of whether this is the case is difficult, if not impossible, to answer.

1.7.2. Future Research

The findings reported in this dissertation also raise some questions for future research. A broad question relates to the match between tax planning pref-erences, efforts, and outcomes. In understanding whether the firm is tax ag-gressive, observing the tax outcomes may not be sufficient. Thus, development of alternative measures capturing the firm level preferences and efforts may be warranted.

Relatedly, an important question that so far has received limited attention in the taxation literature concerns firm level factors that facilitate the imple-mentation of tax planning strategies. For instance, are certain firms or indus-tries better at navigating in the regulatory environment? And, at the firm level, what organizational structures facilitate such behavior?

These questions are closely connected to another issue that calls for fur-ther research. That is, when is tax planning considered as important for the firm? A possible answer to that may lie in the life cycle stage of the firm. As the firms mature, tax planning efficiency may become increasingly important since operational efficiency is approaching its peak. Alternatively, the period when the firm was established may be related to the existence of specific organizational structures that facilitate or constrain corporate tax planning activities.

Finally, as societal views towards corporate tax planning activities are changing, the question arises whether high levels of legal tax avoidance are still valued positively after 2007, i.e. after the end of the sample period used for the investigation of listed Swedish firms. Specifically, the rise of social media and growing importance of the corporate social responsibilities may have changed board attitudes towards extreme tax avoidance. If that is the

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case, the reputational cost effect that was not observed in this dissertation may have become significant during the years not covered in this dissertation.


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