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Conservative management trumps political ideology, as companies headed by Republicans pay more tax than those led by Democrats
It may come as a shock to Occupy Wall Streeters, but one of the groups they most love to hate, top corporate executives of Republican persuasion, turn out to be dutiful taxpayers.
According to a study to be presented at the forthcoming annual meeting of the American Accounting Association (Washington, D.C., August 3-8), companies headed by executives whose political preferences lean toward the Republican Party each pay an average of $12 million more annually in taxes than companies headed by Democratic-leaning executives. Given a mean pretax income of $540.8 million for companies in the sample, this amounts to an extra 2.22%.
The research also finds, that when a company hires a new CEO whose political orientation differs from that of the former chief, the shift helps explain changes in the firm's tax avoidance.
How could chiefs whose favorite political party continually trumpets its commitment to low taxes end up paying more corporate tax than executives whose political allegiance is to a party intent on shutting corporate loopholes? When it comes to company taxes, pro-Republican executives opt for conservative management over political ideology, concludes the study by Dane Christensen, Dan Dhaliwal, and Steven Boivie of the University of Arizona and Scott D. Graffin of the University of Georgia.
Citing a national poll that Republicans are about three times more likely than Democrats to consider themselves to be conservatives, the authors note that "research has found that political conservatives tend to fear losses, value financial security, have greater aversion to ambiguity and uncertainty, and value job security over task variety." Still other research, they observe, has found that "firms run by Republican-leaning managers have more conservative financing, investing, and payout policies."
And so it goes, too, with corporate taxes. "If they set a tone of being conservative, due to their risk-averse nature and desire to avoid uncertainty, that can potentially translate into encouraging the firm's inside and outside tax advisors to be more conservative in their tax strategies. For example, this can lead the firm to pass on using strategies that either may not be upheld by the IRS or that could expose the firm to significant non-tax costs if detected (i.e., fines and penalties, negative publicity, stock price declines, etc.)"
The strongest results emerged for top executive teams (the five highest-paid executives) followed by results for CEOs followed by somewhat weaker results for CFOs.
The study builds on research published two years ago by other scholars in The Accounting Review, an American Accounting Association journal, which revealed that, when it comes to corporate taxes, executives "matter in a big way" -- accounting for differences of as much as 14% in cash paid. But the study failed to determine what accounts for such differences, finding no significant effects related to executives' age, tenure, gender, educational background, and various other aspects of knowledge and experience.
The new research shifts the focus to politics as a reflection of managers' "personal value and belief systems." In the words of the study, "Given how polarizing tax issues have been in political discourse, both in Congress and among individual citizens, political orientation seems like a reasonable candidate. Additionally, because personal political orientation likely captures many broad issues beyond just taxes, personal political orientation likely captures other facets of individuals' personal value and belief systems, which may also be helpful in explaining corporate tax avoidance."
To probe the politics-taxation relationship, the researchers collected thousands of names from a database of corporate executives covering the years 1992 through 2008 and obtained data from the Federal Election Commission on the executives' personal contributions to presidential, Senate, and House candidates as well as party committees. The search produced about 70,000 separate contributions that could be linked to more than 10,000 top executives of S&P 1500 firms -- 3,500 CEOs, 1,600 CFOs and 5,000 others. Managers' political orientation was determined by subtracting the dollar value of contributions to the Democratic Party from that of contributions to the Republican Party and dividing the remainders by total contributions to both parties. Contributions were averaged across election cycles to reduce errors introduced by donations at a particular time to obtain political benefits -- for example, contributions in response to a proposed tax-law change. The analysis included controls for a whole slew of factors that affect company tax rates including, among others, pretax return on assets, leverage, the presence of tax-loss carry-forward, changes in tax-loss carry-forward, and foreign income.
Top executives, the study finds, lean to the Republican Party by a ratio of about two to one. Republicans were favored in all 48 industries that were surveyed with the sole exception of entertainment. Managers who lean toward the Democratic Party are more likely to work for firms that have greater growth opportunities, spend more on research and development, and enjoy a higher tax benefit from stock-option exercises.
The study calculated tax payments in two ways -- in terms of the amount paid to tax authorities and in terms of total tax expense, current plus deferred, reported on company financial statements. By both measures, companies with Republican-leaning top executives pay significantly more tax than companies headed by Democrats.
Political preferences have the most effect on taxes, the study also finds, when top managers are most entrenched, as gauged through the presence of such incumbent-protecting measures as staggered boards, poison pills, and golden parachutes. Republican-leaning chiefs tend to be more entrenched than those favoring Democrats, a pattern, the authors observe, "consistent with conservative managers' creating an environment where it is harder or more costly to fire them, or choosing to work for firms where this environment already exists." Meanwhile, in companies where entrenchment is low, "managers' personal political orientation [whether Republican or Democratic] does not appear to have any explanatory power for their firms' tax avoidance."
The study, entitled "Managers' Personal Political Orientation and Corporate Tax Avoidance," will be among hundreds of scholarly presentations at the American Accounting Association meeting, which is expected to draw more than 3,000 scholars and practitioners to Washington, D.C., from August 3 to 8. The AAA is a worldwide organization devoted to excellence in accounting education, research, and practice. Journals published by the AAA and its specialty sections include The Accounting Review, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Auditing: A Journal of Practice & Theory, and The Journal of the American Taxation Association.