TAX AVOIDANCE AND EQUITY INCENTIVES

Abstract

This study investigates the impact of equity incentives on the degree of tax avoidance. Equity incentives for executives align the interests of executives and shareholders because the former receive awards that share firm value with stockholders. In general, managerial behavior to minimize corporate tax obligations can increase firm value and shareholder wealth. Thus, we expect equity incentives to promote more effective tax avoidance activities. We test two empirical hypotheses: (1) whether the level of tax avoidance is positively related to the equity-based pay of executives; (2) whether executives with higher equity-based pay prefer tax avoidance activities related to permanent differences more than those related to temporary differences. We use a sample of 10,933 firm-year observations (1,107 firms) spanning the period 1992-2011 obtained from ExecuComp, and Compustat. Our results support both hypotheses. We find a larger book-tax difference and a lower effective tax rate in companies with higher equity incentives. We also document that companies’ tax avoidance is more likely to be related to permanent rather than temporary differences when executives receive more equity incentives.