Tax Risk, Corporate Governance, and the Valuation of Tax Avoidance Across Philippine Firms: How Do Investors Value Corporate Tax Avoidance?

Tax avoidance has traditionally been thought to enhance firm value because it generates cash savings for reinvestment or distribution to shareholders. More recent literature, however, suggests that tax avoidance valuation may not be so simple. Desai and Dharmapala (2009) introduced the “agency perspective” on tax avoidance, arguing that investors consider the risk of tax avoidance as opening opportunities for managers to extract rents from their firms. Positive tax avoidance value would therefore be conditional on good corporate governance quality. Drake et al. (2017) introduced yet another dimension—tax risk—to the valuation of tax avoidance, arguing that tax avoidance that comes with less variability in tax outcomes (i.e., comes with lower tax risk) should be preferred to those that come with more because investors prefer stable earnings over risky earnings. This policy brief discusses our findings on how public investors in the Philippines value corporate tax avoidance in the contexts of tax risk and corporate governance quality, and policies that can be implemented to enhance firm transparency, increase tax revenues, and raise firm valuations

Tax risk, corporate governance, and the valuation of tax avoidance across Philippine firms: How do investors value corporate tax avoidance?

Corporate tax avoidance has traditionally been thought to enhance firm value because it generates cash tax savings. Recent literature on tax risk and the agency perspective on tax avoidance, however, suggests that the value of tax avoidance diminishes in certain situations. In tax risk literature, the value of tax avoidance has been observed to diminish when it entails higher tax risk. Investors discount the value of tax avoidance when it produces uncertain tax outcomes. In the literature on the agency perspective on tax avoidance, the value of tax avoidance has been observed at zero to negative when strong corporate governance is absent. Investors assign tax avoidance no value, or even negative value in some cases, when there is a lack of strong corporate governance to prevent rent extraction and protect tax savings. In this study, we examine the effect of tax avoidance on firm value while considering tax risk and corporate governance for non-utility, non-financial, and non-PEZA firms listed on the Philippine Stock Exchange from 2012 to 2019. We employ a two-step generalized method of moments estimation technique using two measures of tax avoidance, two measures of tax risk, and one measure of corporate governance quality to examine any relation between firm value and the set of factors consisting of tax avoidance, tax risk, and corporate governance quality. Consistent with agency theory, we find that investors negatively value tax avoidance. We conclude that for Philippine investors, negative concerns about agency costs arising from tax avoidance activities overshadow positive expectations about their benefits. Furthermore, we ascertain that good corporate governance alleviates the negative valuation of tax avoidance

Corporate governance, firm size, and tax avoidance: How does corporate governance influence tax avoidance across small and large Philippine firms?

Corporate taxes represent costs that are proportional to an entity’s profit, which could substantially impact a firm’s financial bottom line. To improve profitability, many firms have turned to engaging in tax avoidance activities. However, there is growing evidence from recent literature that investors generally value tax avoidance negatively (Assidi et al., 2016; Chen et al., 2014; Herron & Nahata, 2020). Likewise, tax avoidance harms the state by depriving it of tax revenues. If tax avoidance is value-destroying then, good corporate governance mechanisms intended to maximize stakeholder value should limit tax avoidance behavior (Kerr et al., 2016; Aburajab et al., 2019). We extend this analysis further by investigating the potential moderating role of firm size on the effect of corporate governance on tax avoidance. The oversight effect of corporate governance on tax avoidance should be stronger in larger firms, as they are subject to greater reputational risks, following the legitimacy theory (Jensen & Meckling, 1976; Watts & Zimmerman, 1986; Sopiyana, 2022). We employed a two- step generalized method of moments estimation technique to test these hypotheses. Consistent with both the agency and legitimacy theory, we found that corporate governance has a significant negative effect on corporate tax avoidance. We then found that firm size also has a significant negative effect on corporate tax avoidance, following the political cost theory. Finally, we found that firm size positively moderates the effect of corporate governance on tax avoidance. Drawing on these empirical results, we make several recommendations to our primary stakeholders