7th Call - Dr. Mohammed Amidu

Project Title: Do Firms Manage Earnings and Avoid Tax for Corporate Social Responsibility?

Principal Investigator: Dr. Mohammed Amidu (Department of Animal Experimentation, NMIMR.)

Email Address: amidu@ug.edu.gh

Award Amount: GHC 24,990.00

Project Status: On-going

Summary:

This study embeds corporate tax avoidance and earnings management within an agency framework and later incorporates Corporate Social Responsibility using the Stakeholder theory. Friedman (1970) posits that, a corporate executive is an employee of the owners of the business and therefore has direct responsibility to his employers. They are to conduct businesses in accordance with the aim of making as much money as possible while conforming to the basic legal and ethical rules of the society. Similarly, management, as stewards, owes shareholders a duty to maximize profit and shareholder value as best as they can through cost reduction strategies (Campbell, 2007). Taxation is seen as a cost to organizations. It affects organizations’ net cash flow and profitability without offering any direct benefit. Compelled by the profit logic, corporations may organize their affairs in such a way as to pay the least tax possible under the law (Murphy, 2004) by engaging in transactions which in the words of Michael Graetz (2009), are deals ‘‘done by very smart people that, absent tax considerations, would be very stupid.’’ Tax minimization through elaborate and frequently aggressive tax-avoidance strategies is regarded as one of the prime duties that directors are required to perform on behalf of their shareholders (Murphy, 2004). Tax avoidance techniques are secretive in nature and require obfuscation of transactions to guarantee tax benefits while shielding such actions from tax authorities (Desai and Dharmapala, 2009; Murphy, 2004). These mechanisms, thus, give room for opportunistic management to pursue self-seeking objectives and manage earnings in ways that provide benefits to managers and that do not benefit shareholders. This defeats the purpose for avoiding taxes and thus has a negative impact on firm value. It therefore holds that management who engage in earnings management to pursue private gains are more likely to avoid taxes as avoidance offers them a shield to cover up their misdeeds. A Strong positive relationship may exist between the two activities because concealing income from the tax authorities through complex transactions reduces the ability of shareholders to monitor managers’ behavior thereby making diversion less costly for managers (Desai and Dharmapala, 2005). Consequently, decisions about tax avoidance and rent diversion (earnings management) are made simultaneously and are potentially interdependent. The extent of interrelationship between the two however is affected by the governance characteristics of the firm (Desai and Dharmapala, 2009). Some studies suggest that, firms that manage earnings when discovered loses the support of stakeholders, which may lead to increased activism and vigilance from shareholders and other affected stakeholder groups (Prior, Surroca and Tribó (2008). To safeguard from close scrutiny by stakeholder activists (Cespa and Cestone, 2007), such managers engage in corporate social responsibility (CSR). Businesses which stress their social responsibility (CSR) tend to signal that they are good companies and this draws attention away from possible hint that they are engaged in earnings management. Hence CSR can be used as a window dressing strategy to divert attention away from firm’s earnings management behaviour (Jiang et al 2013). If these incentives exist for corporations engaging in earnings management, then, there could be a relationship between tax avoidance, EM and CSR. The study will employ system methods of moments (GMM) estimator to establish whether firms in Ghana manage earning and avoid tax to finance corporate social responsibility.