Abstract/Summary

We examine the influence of corporate compensation policies on firms’ tax aggressiveness in an emerging market where executive compensation is primarily in cash form. Based on a hand-collected dataset of 958 firm-year observations of Chinese listed firms for the 2006-2012 period, we find that firms paying higher executive cash compensation are associated with lower tax aggressiveness. This relationship also holds for the excess cash compensation measures which control for executive shareholding, firm profitability, size, growth opportunity, and board independence. We further document that mutual funds ownership pressure firms paying higher compensation to reduce their tax aggressiveness, suggesting adverse selection by mutual funds on firms exhibiting risky tax avoidance activities. High leverage offsets the negative link between cash compensation and tax aggressiveness, indicating a complementary effect between debt and tax avoidance, and, hence, suggesting that creditor monitoring is weak. These results are robust to the system-GMM estimation, which simultaneously account for the endogeneity of executive compensation, tax aggressiveness, ownership and control, leverage, and corporate governance. Our findings on Chinese firms have important policy implications for developing countries around the world with concentrated ownership structure, weak institutional environment, widespread corruption, ineffective rule of law, and ongoing significant social and political transformation.