Tax and Turnover
Whether chief executive officers shepherd their companies to avoid too much or too little taxation, their reputations suffer and they’ll likely be forced out.
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That’s the key finding of a new study published by the American Accounting Association, Can Paying “Too Much” or “Too Little” Tax Contribute to Forced CEO Turnover?
But the study claims to be the first to link CEOs’ turnover rates and too little taxation when compared to similar companies. What’s more, the trend began after the passage of the Sarbanes-Oxley Act (SOX) in 2002 in the wake of accounting fraud and deception at Enron, WorldCom and other companies.
Why? Because federal regulation and scrutiny of corporations tightened after SOX. “Consistent with increased pressures to be less tax-aggressive, we find that being in the lowest quintile of benchmarked tax rates [became] influential in predicting CEO turnover,” according to study authors James Chyz of the University of Tennessee and Fabio Gaertner of the University of Wisconsin. “This is consistent with boards responding to increased political and reputational costs surrounding tax avoidance.”
The study was conducted prior to the newly passed tax-reform law that imposes a flat 21 percent corporate tax rate – down from 35 percent.
The authors analyzed the effective tax rates of about 5,100 public companies during a 14-year period and the correlation of forced departures of the companies’ CEOs. Effective tax rates were the preferred benchmark for a variety of reasons. They are readily available and “allow for a common measure of relatively high or relatively low tax rates that simplifies our research design and the interpretations of our results,” the authors wrote.
The research revealed two findings:
CEOs are most likely to lose their jobs when company tax rates are high compared to similar companies, with a 20 percent higher job loss than the average for companies in the three middle tax brackets.
On the other hand, CEO turnover also is high when company tax rates are too low – with about 15 percent higher CEO turnovers that for CEOs at companies in the middle three tax brackets.
Why focus on CEOs’ replacement? “Because it represents a deliberate action by the board to modify the firm’s direction, strategy and leadership,” the authors wrote. Their research also found that chief financial officers’ turnover rates are comparable to that of CEOs.
The authors contend that boards appear to hold CEOs accountable for a company’s tax outcomes. And after the CEOs are forced out, their replacements “appear to move firms’ effective tax rates closer to their peers,” the study states. Performance also improves, regardless of whether the company is the lowest or highest tax bracket.
“Thus it appears that, on average, it is rational for boards to engage in tax-motivated evaluation, hiring and retention decisions,” the authors write.