Corporate Tax Payments and Corporate Social ...

Corporate Tax Payments and Corporate Social Responsibility: Complements or Substitutes? Empirical Evidence from Europe Arne Preuß Faculty of Business Management, Kiel University of Applied Sciences, Sokratesplatz 1, 24149 Kiel, Germany

Bj¨orn Preuß∗ Department of International Economics & Management, Copenhagen Business School, Porcelænshaven 24A, 1-4.sal, 2000 Frederiksberg, Denmark

Abstract Recent empirical studies find mixed evidence on the relation between corporate social responsibility and corporate tax payments. We investigate for a European sample, whether the two constructs act as substitutes or complements. We analyse the relation using a linear unobserved effects panel model. Our findings suggest that corporate social responsibility and corporate tax payments act as substitutes. Keywords: corporate social responsibility, corporate tax avoidance

I ∗

Conflicts of interest: stock ownership. Corresponding author is Bj¨ orn Preuß. Email address: [email protected] (Bj¨orn Preuß) URL: http://www.cbs.dk (Bj¨orn Preuß)

Preprint submitted to the editor

August 11, 2017

1. Introduction Hanlon and Heitzman (2010) call for research on the relation between corporate social responsibility (CSR) and corporate tax avoidance. The relation between corporate tax payments (CTP) and CSR has drawn considerable interest of researchers. However, existing research (Lanis and Richardson, 2012, 2015; Davis et al., 2016; Huseynov and Klamm, 2012; Hoi et al., 2013; Landry et al., 2013; Watson, 2015) suggests different relations between CSR and CTP. In addition, there is no study available that analyses European data.1 The different findings and a lack of empirical evidence for European firms motivate our research question: Are CSR and CTP complements or substitutes and why? Recent empirical studies by Lanis and Richardson (2012, 2015); Davis et al. (2016); Huseynov and Klamm (2012); Hoi et al. (2013); Landry et al. (2013) and Watson (2015) differ from ours in either the sample or the CSR measures used. We analyse the relation between CSR and CTP using European panel data. The findings of our study are especially important for European public policy institutions. The results contribute to the understanding of activities that stakeholders consider to be socially responsible. Consequently, the results may help European public policy institutions to produce sustainability guidelines. 2. Literature Review First, we provide definitions of the theoretical constructs of interest. Second, we use verbal theory and findings of empirical research to explain the hypothetical relation between CSR and CTP. 1

Selection process of literature included: Five online databases which could be searched for articles were identified. These include EBSCO, ProQuest, Wiley Online, Science Direct and Emerald Insight within which English language articles were searched using the terms ”corporate social responsibility” combined (connector AND) with the term ”tax”. The search was limited to full texts, the last 16 years (2000 until the middle of 2016), search in abstracts and refereed academic journals. References of all included articles were analysed to identify additional articles. After the exclusion of duplicates, articles were selected and evaluated using a predetermined checklist of criteria. The criteria included: adequate (i) argumentation, (ii) method and (iii) data analysis. The selection and evaluation process was undertaken initially by abstract. For those not excluded by abstract, the selection and evaluation process was conducted by reading the full text.

2

2.1. Corporate Tax Avoidance and Corporate Social Responsibility as Theoretical Constructs We use the conceptual term corporate tax avoidance as tax avoidance decreases CTP. Consistent with Dyreng et al. (2008) and Hanlon and Heitzman (2010), we define tax avoidance broadly as the reduction of tax liabilities. This conceptual term covers legal tax planning activities but also activities that are best described with the terms tax sheltering and tax evasion. Hanlon and Heitzman (2010) summarise the theoretical determinants of tax avoidance, i.e. penalties, tax rates, probability of detection and punishment (Allingham and Sandmo, 1972), management incentives (Slemrod, 2004) and corporate governance (Desai et al., 2007). However, theses theoretical determinants are difficult to measure and empirical research finds several other factors influencing corporate tax avoidance (Hanlon and Heitzman, 2010). CSR goes by many names, has different theoretical foundations (e.g. Garriga and Mele, 2004; Carroll, 1999; Frederick, 1998) and is closely related to similar terms such as social performance (Watson, 2015). CSR implies that economic, legal, discretionary and ethical aspects are incorporated into corporate decision making (e.g. Aupperle et al., 1985; Carroll, 1979; McWilliams and Siegel, 2001). The different interests of non-shareholder stakeholders (e.g. customers, suppliers, employees) should be considered (Carroll, 1991). As environmental attention is an aspect of CSR (Huang and Watson, 2015), a comprehensive term is used to investigate CSR by including ecological aspects into the conceptual term of CSR. 2.2. Relation between Corporate Tax Payments and Corporate Social Responsibility CTP seem to play a conflicting role within the context of CSR. On the one hand, the reduction of CTP increases profitability which is the basis for common CSR activities. On the other hand, governmental activities are funded by taxes. In fact, less agreement exists on the relation between CTP and CSR. Theory has a contrary view on the relation and the findings of empirical studies are mixed. We discuss these different perspectives by summarising, comparing and contrasting previous research of the key authors. First, existing research and theory suggest that there is a positive relation between CSR and CTP. Under stakeholder theory, firms must consider the interests of all stakeholders (e.g. Margolis and Walsh, 2003; Mackey et al., 2007; Donaldson and Preston, 1995; Garriga and Mele, 2004). Tax authorities

3

are included in the group of external stakeholders. Although CTP are not entirely voluntary, managers make decisions about the extent of tax avoidance. Some corporate cultures may be based on stakeholder management and consequently managers may view common CSR and CTP in the same way. In fact, the results of two empirical studies suggest a positive relation between CSR and CTP. Lanis and Richardson (2012) examine the link between CSR and corporate tax aggressiveness. Their sample consists of 408 Australian firms for the years 2008 to 2009. They find based on tobit regressions that corporations with high levels of CSR disclosure are less tax aggressive. A more recent study by Lanis and Richardson (2015) investigates the relation between CSR performance and corporate tax avoidance by employing logit regressions. They examine a sample of 434 firm-year observations that have data on the Kinder, Lydenberg and Domini (KLD) annual data set from 2003 to 2009. Lanis and Richardson (2015, p. 439) conclude “that more socially responsible firms are likely to display less tax avoidance”. In summary, theory and empirical research suggest that corporate culture treats CTP and common CSR in the same way resulting in a positive relation. Second, existing research and theory suggest no relation between CSR and CTP. Under traditional economic theory, managers allocate resources to common CSR actions only to the extent that it maximises shareholder wealth (e.g. Scholes et al., 2015; Chen et al., 2010). Similarly, corporate taxes might be merely perceived as operating expenses that should be minimised as much as possible (e.g. Avi-Yonah, 2008; Scholes et al., 2015). Tax avoider may also benefit from lower cost of equity (Goh et al., 2016). However, there can be economic restrictions of tax avoidance such as the risk of stock price crash due to tax avoidance (Kim et al., 2011) or increased information asymmetry and agency problems between borrowers and lenders resulting in higher financing costs (Lin et al., 2011; Graham et al., 2008). All in all, both tax avoidance and CSR are seen as mechanisms to maximise shareholder wealth that can be used independently from each other. Third, existing research and theory suggest that there is a negative relation between CSR and CTP. Godfrey (2005) argues that corporate reputation based on CSR is especially important when a firm is faced with a negative corporate event. Tax avoidance might result in negative sanctions. In fact, Graham et al. (2014) investigate survey responses from almost 600 corporate tax managers and find that tax executives rate reputational concerns as the second main factor when corporations do not adopt a tax avoidance strategy. Furthermore, Hanlon and Slemrod (2009) find a small negative stock price 4

reaction due to public revelation of tax-sheltering. And corporations based in tax havens claim to engage in CSR (Preuss, 2010). Firms identifying themselves as socially responsible practice tax avoidance strategies (Sikka, 2010). Moreover, existing research and theory of Fombrun et al. (2000); Minor and Morgan (2011) and Godfrey et al. (2009) suggest that corporations engage in CSR to reduce the negative consequences of their publicity. Hence, firms might allocate resources to CSR to hedge against negative consequences of tax avoidance activities. In fact, one empirical study suggests a negative relation between CSR and CTP. Davis et al.’s (2016) recent study employing an OLS and a 3SLS regression investigates the relation between CSR and CTP. Their sample includes 5,588 observations of U.S. public firms that have data on the KLD data set from 2006 to 2011. The findings suggest that CSR is negatively related to CTP. In brief, theory and empirical research suggest that CSR are used to hedge against negative sanctions due to corporate tax avoidance and CTP are not seen as a part of common CSR. Fourth, four empirical studies suggest that there is a mixed relation between CSR and CTP. First, Huseynov and Klamm’s (2012) OLS regression analysis examines the effects of tax management fees and CSR on tax avoidance for a sample of 2,337 firm-years of S&P500 corporations using auditorprovided tax services. They analyse data from 2000 to 2008. Their findings suggest that firms with high measures of CSR concerns tend to have lower CTP. However, Huseynov and Klamm (2012) find no relation between CSR strengths and CTP. Second, Hoi et al. (2013) investigate the association between CSR and corporate tax avoidance for the years 2003 to 2009. Their sample consists of 2,620 U.S. firms. The results of OLS and logistic regressions suggest that corporations with excessive irresponsible CSR are more likely to engage in tax-sheltering. However, they find no relation between CSR strengths and CTP. Third, Landry et al. (2013) investigate the relation between CSR, ownership structure and tax aggressiveness employing OLS regression. The sample includes 168 Canadian firms listed on the Toronto Stock Exchange from 2004 to 2008. Landry et al. (2013, p. 612) conclude “that tax behaviours are not necessarily aligned with CSR”. Last, Watson (2015) examines the effects of earnings performance on the relationship between CSR and corporate tax avoidance. The study analyses a sample of 1,929 U.S. firms from 2003 to 2009. The OLS regression results suggest that the relation between CSR and corporate tax avoidance is moderated by earnings performance and is moreover mixed.

5

3. Econometric Analysis 3.1. Data Our sample initially consists of all firms listed in the MSCI Europe Index in July 2017. For these firms we collected annual financial data and ESG scores for the years 2006 through 2016. Because our CTP measure requires five years of data, our final sample includes just the years 2010 through 2016 (T = 7). Due to data availability the number of cross-sectional units declined from 292 to 95 (n = 95). Our final data set consists of repeated observations on these 95 firms for the years 2010 through 2016. We analyse a balanced panel with 665 observations (N = 665). The main advantage of panel data is that panel econometric techniques allow to control for unobserved, time-constant characteristics (e.g. home country tax system) of our cross-sectional units (Wooldridge, 2010). Annual financial accounting data were obtained from Compustat. Data on CSR ratings were collected from Thomson Reuters. Table 1 presents descriptive statistics. The variables are defined in Appendix A. Hereby, we follow mostly Davis et al. (2016) and partly Hoi et al. (2013) or Watson (2015). We use long-run cash effective tax rates proposed by Dyreng et al. (2008) as a proxy variable for CTP. A high ET R is interpreted as high CTP and a low ET R as low CTP. In contrast to Dyreng et al. (2008), the five-year cash effective tax rate were chosen instead of the ten-year cash effective tax rate. This is consistent with the most current study by Davis et al. (2016). We use long-run cash effective tax rates, not annual cash effective tax rates as annual cash effective tax rates could mismatch the numerator and denominator (Hanlon and Heitzman, 2010). In fact, cash effective tax rates are a frequently used measure for tax avoidance (e.g. Watson, 2015; Hoi et al., 2013; Davis et al., 2016; Chen et al., 2010; Kim et al., 2011; Hope et al., 2013; Phillips, 2003). However, prior research has doubts about the accuracy of cash effective tax rates (e.g. Lisowsky, 2010; Frank et al., 2009; Wilson, 2009). There are two main issues of long-run cash effective tax rates. First, conforming tax avoidance, in which financial accounting income is reduced when the corporate tax avoidance strategy is employed, is not captured by cash effective tax rates (Hanlon and Heitzman, 2010). Second, it may be criticised that cash effective tax rates can have negative values and values greater than one. In the case of a negative sum of pretax income and/or cash taxes paid, long-run 6

Table 1: Descriptive statistics a

Min.

1st Qu.

Median

Mean

3rd Qu.

Max.

ET R CSR SIZE LEV IN T AN G P T ROA ∆SALES F orIN C SG&A R&D PPE CASH GOV CSRtop32 CSRr33−64 LoP T ROA LoP T ROA ∗ CSR

0.00 0.00 4.72 0.00 0.00 -0.02 -0.18 -0.44 0.00 0.00 0.02 0.01 0.00 0.00 0.00 0.00 0.00

0.20 0.00 8.17 0.12 0.10 0.03 0.01 -0.01 0.07 0.01 0.12 0.06 0.00 0.00 0.00 0.00 0.00

0.25 0.00 9.32 0.18 0.19 0.06 0.04 0.00 0.15 0.02 0.21 0.10 0.00 0.00 0.00 1.00 0.00

0.26 0.49 9.35 0.20 0.22 0.07 0.05 0.03 0.16 0.03 0.24 0.12 0.49 0.34 0.38 0.64 0.35

0.31 1.00 10.38 0.27 0.33 0.09 0.07 0.00 0.21 0.04 0.32 0.14 1.00 1.00 1.00 1.00 1.00

0.91 1.00 12.78 0.63 0.78 0.28 0.47 3.30 0.79 0.46 0.76 0.85 1.00 1.00 1.00 1.00 1.00

Variable

a

Variable definitions: ET R = cash taxes paid divided by pretax income less special items, CSR = socially responsible firms are ranked 47th or lower in relation to environmental and social ratings by Thomson Reuters (CSR = 1) otherwise CSR = 0, SIZE = natural logarithm of total assets, LEV = total debt scaled by lagged total assets, IN T AN G = intangible assets divided by lagged total assets, P T ROA = pretax income divided by lagged total assets, ∆SALES = changes in sales scaled by lagged sales, F orIN C = absolute value of foreign exchange income divided by the absolute value of pretax total income, SG&A = selling, general and administrative expense divided by lagged total assets, R&D = research and development expense divided by lagged total assets, P P E = net property, plant and equipment divided by lagged total assets, CASH = cash and short-term investments divided by lagged total assets, GOV = firms with a high level of corporate governance are ranked 47th or lower in relation to governance ratings by Thomson Reuters (GOV = 1) otherwise GOV = 0, CSRtop32 = firms with a high level of CSR are ranked 32nd or lower in relation to environmental and social ratings by Thomson Reuters (CSRtop32 = 1) otherwise CSRtop32 = 0, CSRr33−64 = firms with a medium level of CSR are ranked between 33rd and 64th in relation to environmental and social ratings by Thomson Reuters (CSRr33−64 = 1) otherwise CSRr33−64 = 0 and LoP T ROA = firms with low earnings performance have a P T ROA < 0.07 (LoP T ROA = 1) otherwise LoP T ROA = 0.

7

cash effective tax rates are very difficult to interpret. Dyreng et al.’s (2008) definition of cash effective tax rates does not take these aspects into account. In this context, Dyreng et al. (2008) eliminate firm-years with a negative or zero denominator and winsorize cash effective tax rates at zero and one. Consequently, Dyreng et al. (2008) eliminate 18 percent of one-year observations. But this may result in the problem of data truncation bias which can lead to spurious results (Teoh and Zhang, 2011). For comparability with Davis et al. (2016), observations with five-year cash effective tax rates greater than 1 or less than 0 are eliminated. Consequently, we just anlayse firms with five-year cash effective tax rates between 0 and 1. Consistent with our broad view on CSR, we use a multi-category CSR proxy variable. 4 out of all 7 previous studies use several CSR indices. Hereby, it is common to separate CSR strengths and concerns. Strengths and concerns are analysed separately. However, irresponsible CSR activities may be unintended (e.g. explosion of oil platform). Firms are likely to compensate unintended irresponsible CSR activities with responsible CSR activities. Therefore, CSR concerns as a single CSR activities measure may be rather inappropriate. We argue that a single multi-category CSR measures is more appropriate. CSR ratings by KLD are frequently used within the class of multi-category CSR measures (e.g. Graves and Waddock, 1994; Hillman and Keim, 2001; Waddock and Graves, 1997; Turban and Greening, 1997; Berman et al., 1999; Johnson and Greening, 1999). Similarly, CSR ratings by KLD are used in recent research on the relation between CSR and CTP (Lanis and Richardson, 2015; Davis et al., 2016; Huseynov and Klamm, 2012; Hoi et al., 2013; Watson, 2015) and are a generally accepted CSR measure (Chatterji et al., 2009; Mattingly and Berman, 2006). We argue that CSR cannot be measured as it is a matter of people’s life. Ratings depend on subjective aspects and are characterised by the risk of arbitrariness. However, 5 out of all 7 studies on the link between CSR and CTP use KLD data. We think that research on the relation between CSR and CTP should not refer to a single rating agency. In conclusion, we argue that it seems reasonable to use an alternative, multi-category CSR rating source such as Thomson Reuters. A basic description of Thomson Reuters ESG database is provided in Lys et al. (2015).2 2

It must be mentioned that Thomson Reuters enhanced their ESG database recently.

8

As it is difficult to interpret a one-unit increase in CSR rating and the CSR rating takes on many values, we break it into two categories by using a binary variable. We view a firm-year as socially responsible if the firm-year is ranked 47th or lower in relation to environmental and social ratings by Thomson Reuters (CSR = 1). Otherwise we view a firm-year as socially irresponsible (CSR = 0). We use this interval boundary as it separates the top 50 % from the lowest 50 % of our 95 sample firms in each time period. 3.2. Research Design We analyse the relation between CSR and CTP by estimating the following model for firm i = 1, 2, ...n in time period t = 1, 2, ..., T : ET Rit = β1 CSRit + β2 SIZEit + β3 LEVit + β4 IN T AN Git + β5 P T ROAit + β6 ∆SALESit + β7 F orIN Cit + β8 SG&Ait + β9 R&Dit T −1 X βt Y eart + ci + uit . + β10 P P Eit + β11 CASHit + β12 GOVit + t=1

(1) We follow Davis et al. (2016) in developing our model. In relation to Equation (1), we use however a more general model with less observed variables. Therefore, it can be applied to non-public firms by future research. We do not use observed variables for tax benefit of stock options, market-tobook ratio, tax loss carryforward, excess cash and financial constraints. We add ∆SALES as a growth measure. As we use five-year cash effective tax rates, we use mean values of all financial control variables measured over the same five-year period. We use five-year means for financial variables in order to avoid mismatches and high volatility due to accounting policy. In contrast to Davis et al. (2016), we do not use five-year means for CSR and GOV as we want to investigate annual data and do not expect similar policy impacts in comparison to our financial variables. In contrast to all previous studies, our panel data set allows us to control for all unobserved, time-constant firm characteristics (Wooldridge, 2010). This allows us to analyse firms of different countries and tax systems. We argue that β1 is the difference in ET R between socially responsible and irresponsible firm-years. The variable CSR directly addresses our research question. We estimate our model by the fixed effects estimator. We treat our dependent variables ET R as standard continuous. Gow et al. (2010) emphasise 9

the importance to correct for cross-sectional and time-series dependence in accounting research. Therefore, all t-statistics are calculated using two-way (firm, year) cluster-robust standard errors as introduced by Cameron et al. (2011) and Thompson (2011). 3.3. Results Theory about the relation between CSR activities and CTP was tested to determine whether CSR and CTP are substitutes or complements by using a linear unobserved panel data model. This model was estimated by the fixed effects estimator. We used the package plm for our econometric analysis (Croissant and Millo, 2008; Millo, 2014). Column (1) of Table 2 present the association between CSR and ET R without control variables. In Column (2) of Table 2, we present the results for our Equation (1). We found a negative association that is statistically and economically significant. This suggest that those firm-years with high CSR ratings have significantly lower CTP than other firm-years. An one-unit increase in CSR is associated with a 2 percentage point decrease in ET R, indicating that CSR activities and CTP are substitutes. We emphasise that we do not establish causality in the relation between CSR and CTP. We seek only to provide evidence on association. 3.4. Sensitivity Analysis We broke the CSR rating into three categories in order to analyse the relation in more detail: top 32, 33rd to 64th and 65th to 95th. In Column (3) of Table 2, we present our findings. For CSRtop32 , our results are consistent with our previous findings. However, the coefficient is with 0.01 smaller in comparison to the estimation of Equation (1). Nevertheless, this indicates that firms with a high level of CSR pay less corporate taxes than firms with a medium level of CSR. Finally, it was tested whether the relation between CSR activities and CTP is moderated by low earnings performance. We use for this variation of our baseline regression model the fixed effects estimator as an approximation. Watson (2015) provide evidence that a lack of CSR is positively associated with tax avoidance when earnings performance is low. By including the moderating variable LoP T ROA into the model, we found no statistically significant relation, which indicates that the relation between CSR activities and CTP is not moderated by low earnings performance (see Column (4) of Table 2). Our other results are consistent with our previous findings. 10

11

(-3,67)*** (-1.11) (-0.75) (0.95) (-4.88)*** (0.98) (-0.36) (-3.24)*** (-1.39) (-0.36) (-0.68) (3.59)***

b

Yes 0.22 665

Yes 0.21 665

-0.05 -0.09 0.10 -1.16 0.09 0.00 -0.31 -0.95 -0.04 -0.11 0.01 -0.01 0.00

(3) (-1.14) (-0.65) (1.07) (-4.95)*** (0.81) (-0.18) (-2.57)** (-1.30) (-0.35) (-0.77) (2.36)** (-2.97)*** (-0.74)

b

-0.02 -0.05 -0.10 0.09 -1.17 0.11 -0.01 -0.30 -0.99 -0.04 -0.10 0.01

(4)

(-0.44) (-0.34)

(-2.06)** (-1.12) (-0.74) (0.95) (-4.56)*** (1.00) (-0.39) (-3.25)*** (-1.39) (-0.36) (-0.68) (3.64)***

Variable definitions: ET R = cash taxes paid divided by pretax income less special items, CSR = socially responsible firms are ranked 47th or lower in relation to environmental and social ratings by Thomson Reuters (CSR = 1) otherwise CSR = 0, SIZE = natural logarithm of total assets, LEV = total debt scaled by lagged total assets, IN T AN G = intangible assets divided by lagged total assets, P T ROA = pretax income divided by lagged total assets, ∆SALES = changes in sales scaled by lagged sales, F orIN C = absolute value of foreign exchange income divided by the absolute value of pretax total income, SG&A = selling, general and administrative expense divided by lagged total assets, R&D = research and development expense divided by lagged total assets, P P E = net property, plant and equipment divided by lagged total assets, CASH = cash and short-term investments divided by lagged total assets, GOV = firms with a high level of corporate governance are ranked 47th or lower in relation to governance ratings by Thomson Reuters (GOV = 1) otherwise GOV = 0, CSRtop32 = firms with a high level of CSR are ranked 32nd or lower in relation to environmental and social ratings by Thomson Reuters (CSRtop32 = 1) otherwise CSRtop32 = 0, CSRr33−64 = firms with a medium level of CSR are ranked between 33rd and 64th in relation to environmental and social ratings by Thomson Reuters (CSRr33−64 = 1) otherwise CSRr33−64 = 0 and LoP T ROA = firms with low earnings performance have a P T ROA < 0.07 (LoP T ROA = 1) otherwise LoP T ROA = 0. b *, **, *** Indicate statistical significance at p < 0.10, p < 0.05 and p < 0.01, respectively (two-tailed tests). t-statistics are in parentheses and are calculated based on two-way (firm and time) cluster-robust standard errors (Cameron et al., 2011; Thompson, 2011).

a

Yes 0.06 665

-0.02 -0.05 -0.10 0.09 -1.14 0.11 -0.01 -0.29 -0.99 -0.04 -0.10 0.01

b

Yes 0.22 665

(-2.51)*

(2)

Time dummies R2 Observations

b

-0.03

(1)

0.00 0.00

a

CSR SIZE LEV IN T AN G P T ROA ∆SALES F orIN C SG&A R&D PPE CASH GOV CSRtop32 CSRr33−64 LoP T ROA LoP T ROA ∗ CSR

Variables

Table 2: Regression Results

3.5. Discussion Our finding suggests that CSR and CTP of European public firms act as substitutes. Therefore, we hypothesise in line with Davis et al. (2016) that CTP cannot be viewed as part of CSR. The reason for this is that we identified a negative association between CSR and CTP. We showed that this negative association between CSR and ET R is both statistically and economically significant. Our finding supports the risk-management perspective on the relation between CTP and CSR. European public firms may use CSR as a tool to hedge against public sanctions due to corporate tax avoidance. However, we do not establish causality. We only provide evidence on association. Our result is similar to those of Davis et al. (2016). In contrast to our result, the findings of most previous studies suggest that there is a mixed relation between CSR and CTP (Huseynov and Klamm, 2012; Hoi et al., 2013; Landry et al., 2013; Watson, 2015). A reason for our different result is that we did not analyse CSR strength and weaknesses in relation to CSR separately. 4 out of all 7 previous studies use several CSR indices. Hereby, it is common to separate CSR strengths and concerns. Strengths and concerns are analysed separately. However, irresponsible CSR activities may be unintended (e.g. explosion of oil platform). Firms are likely to compensate unintended irresponsible CSR activities with responsible CSR activities. Therefore, CSR concerns as a single CSR activities measure may be rather inappropriate. Nevertheless, all recent studies find that CSR seem to be a determinant of corporate tax avoidance. Hence, a CSR variable should be added to Wilson’s (2009) financial model of tax sheltering and Mills’s (1998) financial model of noncompliance. We must mention two important limitations. First, we may face the issue of selection bias (Maddala, 1991). The Heckman (1979) procedure can be employed in order to control for selection bias. Selection models are used by tax scholars (e.g. McGuire et al., 2012; Phillips, 2003; Omer et al., 2006). However, most accounting studies do not use the Heckman (1979) procedure correctly (Lennox et al., 2012). Lennox et al. (2012) mention only 2 out of 75 accounting studies that employ this procedure correctly. It is crucial to find reasonable exclusion restrictions (e.g. Little, 1985; Manning et al., 1987). We cannot implement a reasonable selection model as there is a lack of defensible exclusion restrictions. It must be mentioned that our results are limited to firm-years with complete independent variables and ETRs between 0 and 1. Second, we recognise that it is possible that CSR and CTP are endogenous 12

(Davis et al., 2016). However, we could not find reasonable instrumental variables for a 2SLS framework. 4. Conclusion We investigated the relation between corporate tax payments and corporate social responsibility. Because theoretical and empirical research suggest different relations and empirical evidence is not available for European firms, we analysed whether the two constructs are complements or substitutes using a panel data set of 95 European public firms with 695 firm-year observations for the years 2010 through 2016. We found that corporate social responsibility is negatively associated with corporate tax payments. This suggests that corporate tax payments and corporate social responsibility of European public firms act as substitutes. We hypothesise that corporate tax payments cannot be viewed as part of corporate social responsibility. 5. Bibliography Allingham, M., Sandmo, A., 1972. Income tax evasion: A theoretical analysis. Journal of Public Economics 1 (3-4), 323–338. Aupperle, K. E., Carroll, A. B., Hatfield, J. D., 1985. An empirical examination of the relationship between corporate social responsibility and profitability. The Academy of Management Journal 28 (2), 446–463. Avi-Yonah, R. S., 2008. Corporate social responsibility and strategic tax behavior. In: Sch¨on, W. (Ed.), Tax and Corporate Governance. Heidelberg/Berlin Springer, pp. 183–198. Berman, S. L., Wicks, A. C., Kotha, S., Jones, T. M., 1999. Does stakeholder orientation matter? the relationship between stakeholder management models and firm financial performance. The Academy of Management Journal 42 (5), 488–506. Cameron, A. C., Gelbach, J. B., Miller, D. L., 2011. Robust inference with multiway clustering. Journal of Business & Economic Statistics 29 (2), 238–249. Carroll, A., 1979. A three-dimensional conceptual model of corporate performance. The Academy of Management Review 4 (4), 497–505. 13

Carroll, A. B., 1991. The pyramid of corporate social responsibility: Toward the moral management of organizational stakeholders. Business Horizons 34 (4), 39–48. Carroll, A. B., 1999. Corporate social responsibilitiy. evolution of defintional construct. Business and Society 38 (3), 268–295. Chatterji, A. K., Levine, D. I., Toffel, M. W., 2009. How well do social ratings actually measure corporate social responsibility? Journal of Economics & Management Strategy 18 (1), 125–169. Chen, S., Chen, X., Cheng, Q., Shevlin, T., 2010. Are family firms more tax aggressive than non-family firms? Journal of Financial Economics 95 (1), 41–61. Croissant, Y., Millo, G., 2008. Panel data econometrics in r: The plm package. Journal of Statistical Software 27 (2), 1–43. Davis, A. K., Guenther, D. A., Krull, L. K., Williams, B. M., 2016. Do socially responsible firms pay more taxes? The Accounting Review 91 (1), 47–68. Desai, M. A., Dyck, A., Zingales, L., 2007. Theft and taxes. Journal of Financial Economics 84 (3), 591–623. Donaldson, T., Preston, L. E., 1995. The stakeholder theory of the corporation: Concepts, evidence, and implications. The Academy of Management Review 20 (1), 65–91. Dyreng, S. D., Hanlon, M., Maydew, E. L., 2008. Long-run corporate tax avoidance. The Accounting Review 83 (1), 61–82. Fombrun, C., Gardberg, N., Barnett, M., 2000. Opportunity platforms and safety nets: Corporate citizenship and reputational risk. Business and Society Review 105 (1), 85–106. Frank, M., Lynch, L., Rego, S., 2009. Tax reporting aggressiveness and its relation to aggressive financial reporting. The Accounting Review 84 (2), 467–496. Frederick, W. C., 1998. Moving to csr4. Business and Society 37 (1), 40–60. 14

Garriga, E., Mele, D., 2004. Corporate social responsibility theories: Mapping the territory. Journal of Business Ethics 53 (1/2), 51–71. Godfrey, P., Merrill, C., Hansen, J., 2009. The relationship between corporate social responsibility and shareholder value: An empirical test of the risk management hypothesis. Strategic Management Journal 30 (4), 425–445. Godfrey, P. C., 2005. The relationship between corporate philanthropy and shareholder wealth: A risk management perspective. The Academy of Management Review 30 (4), 777–798. Goh, B. W., Lee, J., Lim, C. Y., Shevlin, T., 2016. The effect of corporate tax avoidance on the cost of equity. The Accounting Review 91 (6), 1647–1670. Gow, I. D., Ormazabal, G., Taylor, D. J., 2010. Correcting for cross-sectional and time-series dependence in accounting research. The Accounting Review 85 (2), 483–512. Graham, J. R., Hanlon, M., Shevlin, T., Shroff, N., 2014. Incentives for tax planning and avoidance: Evidence from the field. The Accounting Review 89 (3), 991–1023. Graham, J. R., Li, S., Qiu, J., 2008. Corporate misreporting and bank loan contracting. Journal of Financial Economics 89 (1), 44–61. Graves, S. B., Waddock, S. A., 1994. Institutional owners and corporate social performance. The Academy of Management Journal 37 (4), 1034–1046. Hanlon, M., Heitzman, S., 2010. A review of tax research. Journal of Accounting & Economics 50 (2/3), 127–178. Hanlon, M., Slemrod, J., 2009. What does tax aggressiveness signal? evidence from stock price reactions to news about tax shelter involvement. Journal of Public Economics 93 (1-2), 126–141. Heckman, J., 1979. The sample selection bias as a specification error. Econometrica 47 (1), 153–162. Hillman, A. J., Keim, G. D., 2001. Shareholder value, stakeholder management, and social issues: what’s the bottom line? Strategic Management Journal 22 (2), 125–139. 15

Hoi, C. K., Wu, Q., Zhang, H., 2013. Is corporate social responsibility (csr) associated with tax avoidance? evidence from irresponsible csr activities. The Accounting Review 88 (6), 2025–2059. Hope, O.-K., Ma, M., Thomas, W. B., 2013. Tax avoidance and geographic earnings disclosure. Journal of Accounting & Economics 56 (2/3), 170–189. Huang, X. B., Watson, L., 2015. Corporate social responsibility research in accounting. Journal of Accounting Literature 34, 1–16. Huseynov, F., Klamm, B., 2012. Tax avoidance, tax management and corporate social responsibility. Journal of Corporate Finance 18 (4), 804–827. Johnson, R. A., Greening, D. W., 1999. The effects of corporate governance and institutional ownership types on corporate social performance. The Academy of Management Journal 42 (5), 564–576. Kim, J.-B., Li, Y., Zhang, L., 2011. Corporate tax avoidance and stock price crash risk: Firm-level analysis. Journal of Financial Economics 100 (3), 639–662. Landry, S., Deslandes, M., Fortin, A., 2013. Tax aggressiveness, corporate social responsibility, and ownership structure. Journal of Accounting, Ethics and Public Policy 14 (3), 611–645. Lanis, R., Richardson, G., 2012. Corporate social responsibility and tax aggressiveness: An empirical analysis. Journal of Accounting and Public Policy 31 (1), 86–108. Lanis, R., Richardson, G., 2015. Is corporate social responsibility performance associated with tax avoidance? Journal of Business Ethics 127 (2), 439–457. Lennox, C. S., Francis, J. R., Wang, Z., 2012. Selection models in accounting research. The Accounting Review 87 (2), 589–616. Lin, C., Ma, Y., Malatesta, P., Xuan, Y., 2011. Ownership structure and the cost of corporate borrowing. Journal of Financial Economics 100 (1), 1–23. Lisowsky, P., 2010. Seeking shelter: Empirically modeling tax shelters using financial statement information. The Accounting Review 85 (5), 1693– 1720. 16

Little, R., 1985. A note about models for selectivity bias. Econometrica 53 (6), 1469–1474. Lys, T., Naughton, J. P., Wang, C., 2015. Signaling through corporate accountability reporting. Journal of Accounting and Economics 60 (1), 56–72. Mackey, A., Mackey, T., Barney, J., 2007. Corporate social responsibility and firm performance: Investor preferences and corporate strategies. Academy of Management Review 32 (3), 817–835. Maddala, G., 1991. A perspective on the use of limited-dependent and qualitative variables models in accounting research. The Accounting Review 66 (4), 788–807. Manning, W., Duan, G., Roger, W., 1987. Monte carlo evidence on the choice between sample selection and two-part models. Journal of Econometrics 35 (1), 59–82. Margolis, J., Walsh, J., 2003. Misery loves companies: Rethinking social initiatives by business. Administrative Science Quarterly 48 (2), 268–305. Mattingly, J. E., Berman, S. L., 2006. Measurement of corporate social action: Discovering taxonomy in the kinder lydenburg domini ratings data. Business and Society 45 (1), 1–27. McGuire, S. T., Omer, T. C., Wang, D., 2012. Tax avoidance: Does taxspecific industry expertise make a difference? The Accounting Review 87 (3), 975–1003. McWilliams, A., Siegel, D., 2001. Corporate social responsibility: A theory of the firm perspective. The Academy of Management Review 26 (1), 117– 127. Millo, G., 2014. Robust standard error estimators for panel models: a unifying approach. MPRA Paper No. 54954. Mills, L., 1998. Book-tax differences and internal revenue service adjustments. Journal of Accounting Research 36 (2), 343–356. Minor, D., Morgan, J., 2011. Csr as reputation insurance: Primum non nocere. California Management Review 53 (3), 40–59. 17

Omer, T. C., Bedard, J. C., Falsetta, D., 2006. Auditor-provided tax services: The effects of a changing regulatory environment. The Accounting Review 81 (5), 1095–1117. Phillips, J. D., 2003. Corporate tax-planning effectiveness: The role of compensation-based incentives. The Accounting Review 78 (3), 847–874. Preuss, L., 2010. Tax avoidance and corporate social responsibility: You can’t do both, or can you? Corporate Governance 10 (4), 365–374. Scholes, M. S., Wolfson, M. A., Erickson, M., Hanlon, M., Maydew, E. L., Shevlin, T., 2015. Taxes and Business Strategy: A Planning Approach, 5th Edition. Boston: Pearson. Sikka, P., 2010. Smoke and mirrors: Corporate social responsibility and tax avoidance. Accounting Forum 34 (3/4), 153–168. Slemrod, J., 2004. The economics of corporate tax selfishness. National Tax Journal 57 (4), 877–899. Teoh, S. H., Zhang, Y., 2011. Data truncation bias, loss firms, and accounting anomalies. The Accounting Review 86 (4), 1445–1475. Thompson, S. B., 2011. Simple formulas for standard errors that cluster by both firm and time. Journal of Financial Economics 99 (1), 1–10. Turban, D. B., Greening, D. W., 1997. Corporate social performance and organizational attractiveness to prospective employees. The Academy of Management Journal 40 (3), 658–672. Waddock, S. A., Graves, S. B., 1997. The corporate social performancefinancial performance link. Strategic Management Journal 18 (4), 303–319. Watson, L., 2015. Corporate social responsibility, tax avoidance, and earnings performance. Journal of the American Taxation Association 37 (2), 1–21. Wilson, R., 2009. An examination of corporate tax shelter participants. The Accounting Review 84 (3), 969–999. Wooldridge, J. M., 2010. Econometric Analysis of Cross Section and Panel Data, 2nd Edition. Cambridge/London: MIT Press.

18

Appendix A. Variable Definitions Variable

Definition

ET R CSR

cash taxes paid divided by pretax income less special items socially responsible firms are ranked 47th or lower in relation to environmental and social ratings by Thomson Reuters (CSR = 1) otherwise CSR = 0 SIZE natural logarithm of total assets LEV total debt scaled by lagged total assets IN T AN G intangible assets divided by lagged total assets P T ROA pretax income divided by lagged total assets ∆SALES changes in sales scaled by lagged sales F orIN C absolute value of foreign exchange income divided by the absolute value of pretax total income SG&A selling, general and administrative expense divided by lagged total assets R&D research and development expense divided by lagged total assets PPE net property, plant and equipment divided by lagged total assets CASH cash and short-term investments divided by lagged total assets GOV firms with a high level of corporate governance are ranked 47th or lower in relation to governance ratings by Thomson Reuters (GOV = 1) otherwise GOV = 0 CSRtop32 firms with a high level of CSR are ranked 32nd or lower in relation to environmental and social ratings by Thomson Reuters (CSRtop32 = 1) otherwise CSRtop32 = 0 r33−64 CSR firms with a medium level of CSR are ranked between 33rd and 64th in relation to environmental and social ratings by Thomson Reuters (CSRr33−64 = 1) otherwise CSRr33−64 = 0 LoP T ROA firms with low earnings performance have a P T ROA < 0.07 (LoP T ROA = 1) otherwise LoP T ROA = 0

19