Agency Costs and Tax Planning when the Government is a Major Shareholder

Prior research argues that tax avoidance is beneficial to shareholders. In state owned enterprises (SOEs), taxes are a dividend to the controlling shareholder, the state, but a cost to other shareholders. Therefore, the controlling shareholder of the SOE benefits from less tax avoidance by the SOE. Using a sample of publicly traded companies in China, we find that SOEs exhibit significantly higher income tax rates than do non-SOEs, consistent with less tax avoidance. These results are especially pronounced for local versus central SOEs and during the year in which SOE managers face term performance evaluations. SOE tax rates are negatively associated with stock returns, consistent with investors being aware of the transfer of wealth through less tax avoidance. Overall, the findings suggest SOEs make tax decisions favorable to the controlling shareholder but costly to the minority shareholders, and the state utilizes SOE managers’ career concerns to promote the minimization of tax avoidance. The findings contribute to our understanding of the impact of ownership structure on tax avoidance and to the agency literature on tunneling mechanisms.