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When It Comes to Corporate Taxes, CEOs May Want to Manage to the Middle

By Wisconsin School of Business

May 9, 2017

New research from Wisconsin School of Business finds CEOs are likely to be fired not only for paying too much in taxes, but also for paying too little

If a company is paying more taxes than its competitors, the chief executive officer of that organization is likely to face scrutiny from the board and shareholders, and eventually could be fired if nothing changes. But new research from the Wisconsin School of Business at the University of Wisconsin–Madison finds that CEOs who are too good at avoiding taxes—their companies paying less taxes than their peers—may also get the axe.

Fabio Gaertner, assistant professor of accounting and information systems at the Wisconsin School of Business, and James Chyz of the University of Tennessee, found shareholders and boards want managers to engage in optimal tax planning, avoiding situations where the company is paying too much in taxes, but also avoiding the reputation damage that can come from paying too little.

“Taxes represent a transfer of wealth from shareholders to taxing authorities, so a CEO’s failure to reduce a company’s tax burden is going to raise questions about that person’s stewardship of firm resources,” says Gaertner at the Wisconsin School of Business. “The good news here is that companies are also concerned about their public image and if they are seen to be ‘not paying their fair share’ or not being good corporate citizens, boards see a cost in that and are willing to fire CEOs who are too aggressive in trying to avoid taxes.”

Gaertner and his colleague examined more than 1,400 instances of forced CEO turnover and what company tax rates looked like before and after those leadership changes. Firms paying higher taxes relative to peers were found to have CEO turnover rates 20-22 percent higher than others. At the same time, those paying lower taxes relative to peers saw turnover rates 13-16 percent higher than other firms.

Board concern over the reputational costs of paying too little in taxes seemed to emerge strongly after the implementation of the Sarbanes-Oxley Act of 2002, the corporate tax reform passed in response to the Enron and WorldCom scandals. Gaertner suggests that boards were clearly responding to greater regulatory scrutiny and saw the increased political and reputational costs associated with aggressive tax avoidance practices.

On the other end of the spectrum, CEOs in companies paying high effective tax rates are going to be held responsible for a decline in shareholder wealth. Board members may see such high tax rates as a signal that a CEO is paying insufficient attention to corporate tax outcomes or failing to pursue legitimate opportunities to reduce tax liabilities.

The study focused on CEO turnover as opposed to that of tax directors because past studies have shown that CEOs have a significant impact on corporate policies and decision-making, including tax planning. Since boards hire and fire CEOs and CEOs are more likely to hire and fire tax directors, the employment status of a tax director is considered to be a component of the CEO’s corporate tax management.

The paper, “Can paying ‘too much’ or ‘too little’ tax contribute to forced CEO turnover?” is available in The Accounting Review.