NON-EXECUTIVE DIRECTOR COMPENSATION AND CORPORATE TAX AVOIDANCE

Abstract

This study investigates whether the percentage of equity-based compensation of non-executive directors influences the corporate tax avoidance behaviour of firms. Using a sample of 4,284 firm-year observations from the year 2006 to 2011, I find statistically and economically significant results that reveal a positive association between the percentage of equity-based compensation of non-executive directors and corporate tax avoidance. I also find that the effect induced by equity-based compensation is mainly driven by stock options rather than stock awards, which is attributed to the difference in the payoff structure of the two components. These results suggest that the incentives induced by equity-based compensation motivate the board of directors to engage in effective tax management, which is consequently reflected in the increase in the level of corporate tax avoidance. In my additional analyses, I examine the interaction effect between factors affecting the board’s ability to monitor and the percentage of equity-based compensation on tax avoidance. In particular, I find that the compensation incentives effect on tax avoidance is weaker in the following scenarios: (1) greater control of the Chief Executive Officer over the board; (2) increased research and development intensity of the firm, and (3) lower pre-tax profit margin of the firm. Finally, I investigate the interaction effect of equity-based compensation and tax avoidance on firm value and the result reveals a positive association. This suggests that a higher fraction of equity-based compensation enhances the effectiveness of the board in discharging its duties, and may potentially strengthen the wealth-creating effect of corporate tax avoidance.