Lock them up: Criminal sentence is the answer to corporate tax avoidance

What is it about?

We find that corporate tax avoidance significantly decreases when criminal penalties on corporate officers for aggressive tax reporting are higher. However, civil penalties on firms do not have such an effect. Thus, governments should increases criminal penalty on officers in order to deter corporate tax avoidance.

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Why is it important?

This study makes several important contributions to the literature. First, our study contributes to the literature on the deterrent effect of legal penalties. There is relatively little research in this area. Our findings are consistent with theoretical predictions. We also add to the literature on the relation between agency problems and aggressive tax reporting. Our findings suggest (potentially suboptimal) tax aggressive decisions may be caused by the misaligned incentives created by the legal environment. As a result, penalties on shareholders are less effective in deterring managers' tax avoidance decisions. Thus, managers may make aggressive tax avoidance decisions that cause significant legal costs to shareholders. Finally, this study addresses several calls in the literature for more theory-grounded empirical analysis in multi-jurisdictional tax research. We show that the threat of penalties imposed on officers relates to the firm's tax avoidance behavior.