Corporations caught avoiding taxes appear to bear no reputational cost

April 10, 2014

Who cares? Big deal. So what? Fuhgeddaboudit.

Prof. Jake ThornockThat’s about the extent of collective public outrage upon learning that a business is avoiding taxation, according to new research by Jacob Thornock, an assistant professor of accounting at the University of Washington Foster School of Business.

Thornock and his co-authors ran more than a hundred different tests to identify any reputational costs incurred by firms caught in the act of aggressive tax sheltering. What they found was no long-term cost at all—to the firm, its senior leadership, or its auditor. No drop in stock price. No damage-control advertising splurge. No slip in media reputation. No symbolic ousting of leadership. No plunge in sales.

On average, the firm and its leaders bore no pain.

“Across a battery of tests,” Thornock says, “we find little evidence that firms or their top executives bear significant reputational costs as a result of being accused of engaging in tax shelter activities, nothing that would stick to them in the long-term like a scarlet letter.”

Legal but unliked

Tax avoidance is an art perfected by many American corporations. Unlike tax evasion, which is unlawful, tax avoidance involves the numerous legal loopholes through which clever accountants can avoid paying the full federal corporate income tax rate of 35 percent. Sheltering strategies range from the classic offshore subsidiaries to corporate owned life insurance policies to liquidating real estate investment trusts.

But if exploiting loopholes is legal, then why doesn’t every company do it? Why do some firms shelter earnings to reduce their tax burden toward zero, while others pay full freight? Scholars call this the “under-sheltering puzzle.”

“The question is not, ‘Why does a chicken cross the road?’” Thornock says. “It’s, “Why don’t all of the chickens cross the road?’”

The most plausible reason is fear. Thornock says that any tax director would tell you that fear of costs to firm reputation is an important factor in deciding whether to use a tax shelter.

This makes sense. Tax shelters are unpopular. The revelation that a company is using them to avoid paying its fair share commandeers headlines and incites loud condemnation from the punditry. But does it do any real harm to the firm, its leadership, or its bottom line? Does anyone really care?

Perception v. reality

To find out, Thornock and co-authors John Gallemore and Edward Maydew began probing for consequences to aggressive tax sheltering.

They analyzed 118 firms that had come under public scrutiny for engaging in sheltering schemes. Scouring the period just after their schemes were revealed, they searched for any sign of material cost—CEO or CFO ouster, auditor removal, decline in sales, spike in advertising expenditures, slide in stock price, among scores of tests. They even considered whether the firm slipped in the Forbes “Most Admired Companies” listing.

But in test after test, the authors found no significant reputational consequences to even the most aggressive forms of tax avoidance in the long-term. Any initial negative reaction from investors was quickly reversed.

Moreover, the firms continued avoiding taxation even after being caught in the act.

Mystery remains

Why don’t we care more about the brazen efforts of corporations to reduce their tax bill to the greatest extent possible? Thornock believes we may view these firms in much the same way that we view celebrities behaving badly. “Brittany Spears shaves her head, has a public meltdown, goes into rehab, hits rock bottom,” he says. “And two years later she has a new album, a successful world tour, and her fans have forgiven her.

“Our capacity to forgive—or maybe forget—is enormous. And aggressive tax avoidance is something that gets cached into the back of our memories, eventually disappearing with the news cycle. It’s something that matters less than you’d expect.”

As for that original question that drove this investigation, the question of why some corporations choose not to avoid taxes when it’s perfectly legal… the jury is still out. “I’m afraid the under-sheltering puzzle is more of a puzzle as a result of our paper,” Thornock adds. “There’s more thinking to be done.”

“The Reputational Costs of Tax Avoidance” is forthcoming in the journal Contemporary Accounting Research.