By Erica Neuman, University of Dayton and Curtis Farnsel, University of Dayton
When corporations based in areas of above-average income inequality pay more taxes, it’s not just the public that appreciates it – investors do, too. That’s the key finding of our recent research published in the journal Accounting and the Public Interest.
Our finding challenges traditional economic theory holding that investors see corporate taxes as a transfer of wealth from shareholders to the state. That would suggest investors value only strategies that minimize taxes. The reality isn’t so simple.
As accounting professors at the University of Dayton, we study the intersection of corporate taxes and corporate social responsibility. We wanted to better understand how corporate taxes affect firm value and stock prices, and whether that relationship changes if a company is headquartered in an area with high income inequality.
So we looked at financial data from over 1,500 firms over a 10-year period between 2011 and 2019, as well as the income inequality in the metro areas where they’re headquartered. For the latter point, we used the Gini coefficient, a measure of income distribution in a given place. This is a particularly useful context for looking at corporate taxes, since one of the key functions of taxation is to counter inequality.
We found that there’s a negative relationship between corporate taxes and firm value for companies headquartered in areas of average inequality. In other words, paying more corporate taxes lowers firm value. That’s in line with previous research and traditional economic theory.
Free Reports:
However, we found that when local income inequality rises above the average, the relationship between corporate taxes and firm value flips. This flip suggests that some companies actually receive a financial benefit from paying corporate taxes.
Why? We found that these companies enjoy a reputational benefit for being socially responsible taxpayers. Indeed, our results were driven by businesses that are are otherwise widely viewed as good corporate citizens. For those companies, paying taxes represents one of many socially responsible behaviors.
Why it matters
Our research offers evidence that investors view corporate taxes positively when they’re consistent with other socially responsible behaviors. Given that corporations have a fiduciary duty to their shareholders, this finding suggests that corporate taxes can play a role in a company’s corporate social responsibility, or CSR, efforts.
Our findings also align with a 2023 KPMG survey of more than 300 chief tax officers that found more than half said they cared more about looking like good corporate citizens than reducing their tax burdens.
An extensive body of research has shown that companies’ investments in CSR activities aren’t just selfless – they’re linked with improved operational and financial outcomes. There’s evidence that businesses that prioritize CSR are better able to attract quality employees; have improved corporate reputations; and are more profitable as judged by return on assets, return on equity and return on sales.
While work on tax responsibility has lagged behind other CSR research, evidence is mounting that paying corporate taxes has positive effects. Much of this research indicates that companies that aggressively minimize tax payments and gain a reputation as “tax avoiders” face harm to their reputation – and therefore, the bottom line.
Our study dovetails this research and identifies a specific context in which investors view corporate taxes favorably. At a time of tax reform both globally and in the U.S., and as lawmakers and pundits continue to call for greater tax transparency, companies should be aware of the role of corporate tax responsibility in their overall CSR portfolio.
What’s next
Corporate tax responsibility is complex and not yet well defined. Our current research examines other circumstances that lead investors to value corporate taxes, which will help companies to quantify the value of including taxes in their CSR portfolios.
The Research Brief is a short take about interesting academic work.
About the Author:
Erica Neuman, Assistant Professor of Accounting, University of Dayton and Curtis Farnsel, Assistant Professor of Accounting, University of Dayton
This article is republished from The Conversation under a Creative Commons license. Read the original article.