The perception that corporate tax avoidance represents a shift of value from the government tax authority to shareholders has been questioned by recent studies that finds this perception to not be legitimate in the data. In this study, I point out the evidence of the positive relationship between tax avoidance and firm level investment so that to provide an evidence of the managers’ behavior of using savings from tax avoidance to fund firms’ investment activities. Furthermore, this study, examine the effect of earnings quality and internal resource on the relationship between tax avoidance and firm level investment.
I collected data of 3085 firms from the KisValue database with accounting data for companies listed on the Korea Stock Exchange (KOSPI) from 2012 to 2017, to test the effect of earnings quality and internal resource on the relationship between tax avoidance and firm level investment. I start with year 2012 because in 2012, International Financial Reporting Standards (IFRS) adoption becomes compulsory to all listed companies in Korea. In contrast from previous research, this study looks at the relationship of tax avoidance and firm level investment from a different perspective by focusing on the effect of earnings quality and internal resource on this relationship.
The evidence of this study suggests that tax avoidance is positively associated with firm level investment. In other words, when firms increase tax avoidance, the firm level investment also increases. Adding to Dobbins and Jacob (2016) and Axel and Joachim (2017) research that found lowered tax rates, induce higher investments. This study also finds the evidence that the relationship between tax avoidance and firm level investment depends on the availability of internal resource and the level of earnings quality. The relationship between tax avoidance and firm level investment is negative when the firm has greater internal resource and better earnings quality. These results suggesting that; firms with the presence of greater internal resource (i.e. internally generated cash flow) tend to rely less on tax avoidance to fund their investment than those firms with low internal resource. Similarly, firms with better earnings quality tend to rely less on tax avoidance to finance their investment than firms with poor earnings quality.
Table of Contents
Chapter 1 Introduction
Chapter 2 Literature Review
2.1. Tax Avoidance and Internal Resource
2.2. Internal Resource and Investment
2.3. Tax Avoidance and Investment
2.4. Tax Avoidance and Earnings Quality
Chapter 3 Research Design
3.1. Hypothesis
3.1.1. Relationship between Tax Avoidance and Firm Level Investment
3.1.2. The Effect of Earnings Quality on the Relationship between Tax Avoidance and Firm Level Investment
3.1.3. The Effect of Internal Resource on the Relationship between Tax Avoidance and Firm Level Investment
3.2. Model Development
3.3. Variable Measurements
3.3.1. Dependent Variable
3.3.2. Interested Variable
3.3.3. Control Variable
3.3.4. Summary of Variables and their Measurements
3.4. Sample Selection
Chapter 4 Empirical Results
4.1. Descriptive Statistics
4.1.1. Dependent Variable
4.1.2. Interested Variable
4.1.3. Control Variable
4.2. Correlations
4.3. Regression
4.3.1. Relationship between Tax Avoidance and Firm Level Investment
4.3.2. The Effect of Earnings Quality on the Relationship between Tax Avoidance and Firm Level Investment
4.3.3. The Effect of Internal Resource on the Relationship between Tax Avoidance and Firm Level Investment
Chapter 5 Conclusions
Research Objectives and Topics
This study aims to investigate the influence of earnings quality and internal resources on the relationship between corporate tax avoidance and firm-level investment. It specifically seeks to understand whether managers utilize tax savings to fund investment activities and how this dynamic shifts based on the firm's financial health and reporting transparency.
- Evidence of the relationship between tax avoidance and firm-level investment.
- The moderating role of earnings quality in corporate investment behavior.
- Impact of internal resources (free cash flow) on the utilization of tax savings.
- Analysis of capital market imperfections and their effect on corporate financing constraints.
- Empirical evaluation of Korean firms listed on the KOSPI index.
Excerpt from the Book
3.1.2. The Effect of Earnings Quality on the Relationship between Tax avoidance and Firm level Investment.
Given the monitoring role of earnings quality, in this study, I expect the extent to which tax avoidance relates to firm level investment to vary with the firm’s earnings quality. Ayers, Jiang and Laplante (2009) find the evidence which suggests that the comparative information content of taxable income for low earnings quality firms versus other firms increased significantly post-1992, a period marked by increased concerns of opportunistic earnings management. Specifically, the positive relationship between tax avoidance and earnings quality is stronger in low earnings quality firms than other firms. According to Desai and Dharmapala (2006), a real world tax shelter is dissected to demonstrate how tax shelter results enable managers to manipulate reported earnings for their own benefit. Desai and Dharmapala (2006) point to a substitute view, emphasizing that tax avoidance demands obscurantist actions that can be bundled with distraction activities, including exploitation of earnings report to raise the interests of managers rather than shareholders. Bushman and Smith (2001) note that high quality financial report helps managers identify profitable projects and also discipline managers’ project selections.
A firm’s information environment is an important component of the firm’s corporate governance that summarizes the control and use of resources by those accountable for its control and use of those resources (Rosenfield, 1974). In addition, prior studies document that a firm’s earnings quality relates to its investment behavior (Biddle and Hilary, 2006). Furthermore, Biddle, Hilary and Verdi (2009) suggest that higher financial reporting quality can reduce managerial incentives to engage in value destroying investments or negative NPV projects for their own benefit by disciplining and monitoring them. They also argue that higher financial reporting quality can help to reduce overinvestment problem in the firm by allowing constrained firms to attract capital by making their positive NPV projects more visible to investors, hence depend less on internal resource like cash savings from tax avoidance.
Summary of Chapters
Chapter 1 Introduction: Provides an overview of the role of tax avoidance in increasing cash flows and its potential impact on corporate investment within imperfect capital markets.
Chapter 2 Literature Review: Synthesizes existing research on the connection between tax avoidance, internal financial resources, earnings quality, and firm-level investment outcomes.
Chapter 3 Research Design: Outlines the formulated hypotheses regarding tax avoidance and investment, details the regression models used, and explains the variable measurement criteria.
Chapter 4 Empirical Results: Presents the descriptive statistics, correlation matrices, and regression analysis findings for the three main hypotheses tested against Korean firms.
Chapter 5 Conclusions: Summarizes the study’s findings, acknowledging the positive correlation between tax avoidance and investment while noting the moderating effects of internal resources and earnings quality.
Keywords
Tax Avoidance, Investment, Earnings Quality, Internal Resource, Imperfect Capital Market, Corporate Finance, Cash Flow, Financial Reporting, KOSPI, Capital Allocation, Information Asymmetry, Managerial Discretion, Tax Planning, Firm-level Investment, Capital Rationing.
Frequently Asked Questions
What is the primary focus of this research?
This research examines whether corporate tax avoidance is linked to higher levels of firm-level investment and how internal resources and earnings quality moderate this relationship.
What are the central themes discussed in this study?
The central themes include corporate tax strategy, capital allocation, the impact of internal versus external financing, and the role of information transparency in preventing agency conflicts.
What is the core research question?
The study asks if companies use cash savings from tax avoidance to fund investments, and if this behavior changes when firms have different levels of internal resources and earnings quality.
Which scientific methodology is utilized?
The author uses a quantitative approach, performing ordinary least square (OLS) regression analysis on a dataset of 3085 firm-year observations from Korean listed companies (KOSPI).
What does the main body of the work cover?
The main body covers the theoretical framework, the development of three specific hypotheses, the construction of regression models for testing these hypotheses, and an empirical analysis of the results.
Which keywords best describe this study?
Key terms include Tax Avoidance, Investment, Earnings Quality, Internal Resource, and Imperfect Capital Market.
How does earnings quality influence the relationship between tax avoidance and investment?
The study finds that firms with higher earnings quality tend to rely less on tax avoidance savings for funding investments compared to firms with poor earnings quality, as they possess better financial transparency and governance.
What effect do internal resources have on corporate tax avoidance behavior?
Firms with greater internal resources (internally generated cash flow) demonstrate a reduced reliance on tax avoidance to fund their investment activities compared to those with limited internal capital.
What limitation does the author acknowledge regarding the data?
The author notes potential limitations regarding the generalizability of investment measurements due to limited data access for some companies and the reliance on only two proxies for tax avoidance.
- Quote paper
- Cesilia Mgimwa (Author), 2019, The effect of Earnings Quality and Internal Resource on the relationship between Tax Avoidance and Firm level Investment, Munich, GRIN Verlag, https://www.grin.com/document/537765
