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This study investigates how the interplay between internal corporate governance and the changes in the tax and corporate governance environment in the U.S. during the early 2000s affected firms' tax avoidance levels. Analyses use a panel of U.S. firms for the period 1997–2005 and permanent book-tax difference and cash effective tax rates as proxies for tax avoidance. Results suggest that, relative to other firms, firms with weakgovernance during the low-regulation period (years 1997–2000) exhibited lower tax-avoidance levels during the high-regulation period (years 2003–2005) in response to the tighter external monitoring regime. The study adds to the corporate tax avoidance literature by providing evidence regarding the importance of considering external monitoring regimes in the study of the relationship between corporate governance and tax avoidance.
7. Conclusions and limitations
I examine how firms' tax avoidance levels were affected by the external monitoring changes of the early 2000s given firms' governance strength prior to the changes (the low-regulation period). Results indicate weakly governed firms exhibit lower tax avoidance levels than other firms in the sample during the high-regulation period. The results suggest that the regulatory regime changes of the early 2000s increased external monitoring and induced firms that were previously weakly governed to improve their internal functions and identify areas of tax risk that needed adjusting resulting in lower tax avoidance levels relative to other firms. The results also suggest a reduction in managers' opportunities to use tax avoidance for short-term firm profitability goals because of the increased scrutiny by regulators and the public.
The study contributes to our understanding of the relationship between tax avoidance and corporate governance. By focusing on the period after the regulatory changes of the early 2000s, the study adds to the findings that support a link between weak corporate governance and tax avoidance. An important feature of my study is that the corporate governance effects documented herein are based on a comprehensive corporate governance score that captures the complexity of the corporate governance construct. In contrast, other studies in this stream of literature (e.g., Armstrong et al., 2015; Blaylock, 2016; Seidman & Stomberg, 2017) use single or disaggregated measures of corporate governance that may fail to capture the multi-dimensional aspects firms' corporate governance structures. The study also furthers our understanding of moderating effect of firms' external monitoring environment on the effect of corporate governance on tax avoidance. As such, the study highlights the importance of considering the strength of both external and internal monitoring structures when analyzing the impact of changes in regulation on tax avoidance.