The Differential Choice of Tax Strategy on Ownership Structure
Authors:   Asia-Europe Perspective Association, Hong Young-Eun , Shin Yong-Ho 
Published: June 2018

Given the agency problem issues arising from the separation of ownership and control, the relationship between ownership structure and agency problem is explained by the management entrenchment hypothesis and interest alignment hypothesis. However, there are very few study about the relationship between tax strategy and ownership structure. In settings of tax-book conformity, the financial reporting cost and the tax cost generate opposing incentives because increasing earnings accelerates tax payment as well. Therefor, managers frequently encounter situations involving a trade-off between financial reporting and tax reporting incentives. Financial reporting is an important non-tax consideration for many managers who rely on capital markets to raise investment funds. Managers may wish the company to appear very profitable to reflect appropriately firm value or managerial performance, or to facilitate the issuance of new debt or equity securities. But at the same time, these managers may not wish the company to appear as profitable when preparing tax returns. the tension between financial and tax reporting is pervasive because many actions that increase income for one reporting purpose will increase income for the other as well. Insight into the resolution of the tension between theses two reporting relations is found in the model of manager myopia developted by Stein(1989). This analytical work predicts that managers who face greater capital market pressure will place greater importance on short-term financial reporting implications of a proposed action at the expense of long-term value. The purpose of this paper is to study the differential choice of tax strategy on ownership structure based on agency problem issues arising from the separation of ownership and control. To do this, first, it is necessary to measure the effective tax strategy. Scholes et al.(2005) argues that traditional approaches to tax planning fail to recognize that effective tax planning and tax minimization are very different things. Effective tax planning involves considering the role of taxes when implementing the decision rule of maximizing after-tax returns. In a world of costly contracting, implementation of tax minimization strategies may introduce significant costs along nontax dimensions. Therefore, the tax minimization strategy may be undesirable. Effective tax planning requires the three themes. First, effective tax planning requires the planner to consider the tax implications of a proposed transaction for all parties to the transaction. Second, effective tax planning requires the planner, in making investment and financing decisions, to consider not only explicit taxes(tax dollars paid directly to taxing authorities) but also implicit taxes(taxes that are paid indirectly in the form of lower before-tax rates of return on tax-favored investments). Third, effective tax planning requires the planner to recognize that taxes represent only one among many business costs and all costs must be considered in the planning process: to be implemented, some proposed tax plans may require exceedingly costly restructuring of the business. In sum, effective tax planning should consider all costs, all taxes and all contracting parties. However, it is difficult to measure effective tax strategy including all costs, all taxes and all contracting parties. To measure this, we develop and describe a new measure of effective tax strategy(ETR). Furthermore, we use the ETS to examine the differential choice of tax strategy on ownership structure. In our sample of 1,585 firms, we find that higher the largest shareholder's holding, the more effective tax strategy.