In a new study, we investigate the relationship between executives who exploit their position in the firm to reduce their tax liabilities (i.e., “personally tax aggressive” executives) and corporate violations across various activities, including workplace safety and environmental regulations. Specifically, we examine executives who consistently gift corporate stock at or near the maximum of the distribution of the firm’s stock price during the year, yielding substantial personal tax benefits. Prior research (Yermack, 2009; Avci et al., 2016; Yost and Shu, 2022) finds that suspiciously well-timed stock gifts often result from insiders opportunistically timing gifts based on their private information and/or fraudulently backdating gifts to dates with a high stock price, and such gifts are routinely made to executives’ private foundations. Our motivation stems from recent work suggesting managers’ behavioral traits carry over to their corporate decision-making. We hypothesize that personally tax-aggressive executives have a greater propensity to “cut corners” regarding other types of regulations, such as underinvesting in workplace safety or environmental protection measures, just as they cut corners on tax laws. Consequently, we expect firms employing such executives to exhibit increased regulatory violations.
For two main reasons, insider stock gifts provide a uniquely powerful setting to identify executives who tend to cut corners for personal gain. First, insiders have a strong monetary incentive to donate corporate stock at a high price. Donors receive sizable tax benefits from making charitable gifts of stock, and the value of those benefits is directly tied to the stock’s market value at the time of the gift. Second, unlike other insider stock transactions, stock gifts are only loosely regulated and are subject to relatively low litigation risk. For instance, whereas the Sarbanes-Oxley Act of 2002 (“SOX”) requires insiders’ open market stock purchases and sales to be reported to the SEC within two business days, insider stock gifts can be reported up to 45 days after the firm’s fiscal year-end. The twin features of motive and opportunity have led to significant abuse, with some insiders using their private information to strategically time corporate stock donations and/or exploit the lax reporting rules to backdate gifts to dates with a high price. We argue that these features give researchers a unique opportunity to identify executives who tend to cut corners.
We test our central hypothesis by examining the effect of personally tax-aggressive executives on the likelihood, number, and severity of corporate regulatory violations. We classify executives as personally tax aggressive if at least 30% of their career corporate stock donations occur above the 95th percentile of the distribution of the firm’s daily stock prices that could have been chosen within each fiscal year. Using these criteria, 21.2% of our sample firm years are classified as employing one or more personally tax-aggressive executives. We use the Good Jobs First Violation Tracker database to obtain corporate violations and related penalty amounts.
Using a firm-year panel and violation data from 2000-2020, we examine the influence of personally tax-aggressive executives on corporate violations after controlling for relevant firm characteristics, industry, and year-fixed effects. The likelihood, number, and severity of corporate violations are significantly higher when the firm employs a tax-aggressive executive. Economically, firms with a personally tax-aggressive executive are 5.3% more likely to commit a violation than firms without such an executive; a 33.8% increase relative to the sample mean. Similarly, firms with tax-aggressive executives commit 44.3% more violations and incur 35.3% higher penalties than the sample means. The findings translate to approximately $678,000 more annually in direct economic penalties. Grouping the violation types into six major areas – workplace safety, environmental, employment, consumer protection, competition, and financial – we find that tax-aggressive executives are associated with significantly more violations.
In cross-sectional tests, we posit that strong outside monitoring and influential stakeholders can ameliorate the observed positive relation by holding managers accountable for corporate decisions leading to violations. We proxy for outside monitoring using firm-level institutional ownership and analyst coverage, and we proxy for influential stakeholders using the prevalence of labor unions in the firm’s headquarters state and county-level social capital. Consistent with our expectations, strong outside monitors and influential stakeholders significantly mitigate the link between tax-aggressive executives and corporate violations.
To better glean the causal interpretation, we analyze the arrivals and departures of tax-aggressive executives. Examining four years before and four years after each transition, we find firms exhibit a significant increase (decrease) in corporate violations following the arrival (departure) of a tax-aggressive executive relative to control firms. Moreover, we find evidence that prior to the arrival/departure of a tax-aggressive executive, treated and controlled firms exhibit parallel trends in corporate violations. The findings are consistent with personally tax-aggressive executives driving corporate regulatory violations.
To shed light on the channels through which personally tax-aggressive executives drive increased violations, we examine corporate investment into two major areas of regulatory concern: workplace safety and environmental protection, which constitute 85% of total regulatory violations. We conjecture and find evidence that executives who exhibit aggressiveness concerning tax laws may not feel compelled to invest in measures to comply with regulatory mandates, reflected as lower corporate investments in safety-related expenditures and environmental efficiency (as evidenced by higher toxic releases).
We also seek to differentiate our stock gift-based approach to identifying corner-cutting executives from a stock option-based approach used by prior studies. For instance, Biggerstaff et al. (2015) identify unethical CEOs as those who benefit from backdated stock option grants and find that firms with such CEOs exhibit greater fraud and earnings management. However, the option-backdating approach has been of limited use in recent years due to the accelerated reporting requirements imposed by SOX, which severely curtailed backdating. Since stock gifts were exempt from the SOX reporting requirements, we contend they continue to be useful for identifying corner-cutting executives. As expected, we find that executives who benefit from options backdating are associated with more corporate violations in the pre-SOX era, but that association disappears in the post-SOX era. In contrast, executives who make tax-aggressive stock gifts are associated with significantly more corporate violations in both the pre-SOX and post-SOX eras, confirming the continued usefulness of stock gifts in identifying corner-cutting executives.
We conduct several additional analyses to strengthen our inferences’ validity and ensure our findings’ robustness. First, we perform falsification and placebo analyses in which we test and find no relation between executives who tend to donate stock at lower price levels (i.e., “non-tax aggressive executives”) and corporate violations. Second, we perform matching procedures to mitigate the concern that firms with and without personally tax-aggressive executives are fundamentally different. Third, we use historical stock gift transactions over rolling time windows to investigate whether an executive’s past gifting behavior can predict future violations. Finally, we perform a battery of robustness tests, including: 1) analyzing different subgroups of top executives, 2) using alternative minimum thresholds for stock gifts and executives to be considered “tax aggressive,” and 3) controlling for industry × year, state, and firm fixed effects. Our findings in all cases support our main inferences.
Overall, our study extends prior work on the role of managerial traits in corporate decision-making by showing that managers who tend to cut corners for personal tax gains make corporate-level decisions leading to more regulatory violations. We also introduce a novel approach to identifying personally tax-aggressive executives that we think will be useful for future research.
Benjamin P. Yost is an Assistant Professor of Accounting at Carroll School of Management, Boston College.
Enshuai Yu is a Ph.D. candidate in accounting at Carroll School of Management, Boston College.
This post is adapted from their paper, “Corner-Cutters: Personally Tax Aggressive Executives and Corporate Regulatory Violations,” available on SSRN.
