Increasing levels of institutional investment in companies could be encouraging corporations to pursue tax shelters and other forms of tax avoidance, according to a pair of academic studies.
Passive institutional ownership has a “significantly positive relationship” with tax avoidance, according to one of the studies, conducted by Mozaffar Khan of the University of Minnesota, Suraj Srinivasan of Harvard Business School and Liang Tan of George Washington University. The paper appears in the March issue of The Accounting Review, published by the American Accounting Association.
They did not claim institutional investors are clamoring for tax avoidance strategies, but investors naturally flock to companies that can demonstrate strong after-tax earnings.
Institutional owners “need not explicitly and specifically promote tax avoidance,” said the study. “Managers likely have heightened incentive to show better after-tax performance in order to justify their compensation to new institutional investors...In this scenario taxes are just another line-item expense, and institutional owners do not have to explicitly dictate which line item...managers should manage better.”
Another study, by Andrew Bird and Stephen A. Karolyi of Carnegie Mellon University, in The Accounting Review’s January/February, reached similar conclusions. It found that a 10 percent increase in institutional ownership “precedes declines in effective tax rates on the order of two percentage points, or 8-12 percent.”
They found that a “1 percentage point increase in institutional ownership is associated with a 1.3 percent increase in the likelihood of having a subsidiary in at least one tax-haven country, a 2.2 percent increase in the number of subsidiaries in tax havens in total, and a 0.6 percent increase in the number of distinct tax-haven countries in which a firm is active.”