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Tax avoidance
Tax avoidance and firm value: and firm value
evidence from China
Xudong Chen, Na Hu and Xue Wang
The School of Accounting, Southwestern University of Finance and Economics, 25
Chengdu, China, and
Xiaofei Tang Received 13 September 2013
Revised 17 November 2013
The School of Business Management, Accepted 24 December 2013
Southwestern University of Finance and Economics, Chengdu, China

Abstract
Purpose – The purpose of this study is to examine whether corporate tax avoidance behavior
increases firm value in Chinese context. A large number of studies conduct their designs on the
consumption that tax avoidance represents wealth transfer from government to enterprises and
therefore enhances firm value. This study argues that, contrast to developed countries, tax avoidance
does not necessarily add value to opaque Chinese firms relative to transparent counterparts due to
higher agency costs.
Design/methodology/approach – Using a large sample of Chinese listed-firms data for the period
2001-2009 and fixed effects regression model, this study examines the relation between tax avoidance
and firm value. A series of robustness checks are conducted to alleviate the concern of endogeneity.
Findings – The authors find that tax avoidance behavior increases agency costs and reduces firm
value. The authors further find that information transparency interacts with corporate tax avoidance,
moderating the relation between tax avoidance and firm value. Investors in China react negatively to
corporate tax avoidance behavior, but this negative reaction could be mitigated by information
transparency. The results are robust to a series of alternative treatments, including varied measures,
first-order differential approach and 2SLS.
Originality/value – The results suggest that tax avoidance does not necessarily increase firm value,
part of gains are encroached by self-serving managers. Moreover, investors in China downplay
the significance of tax avoidance, although corporate information transparency could soften their
negative tone.
Keywords Tax avoidance, Firm value, Information transparency
Paper type Research paper

1. Introduction
Tax avoidance is an important corporate strategy (Cai and Liu, 2009; Hanlon and
Heitzman, 2010). Traditionally, it is believed that corporate tax avoidance represents
wealth transfer from government to corporations and should enhance firm value.
Nevertheless, tax avoidance is not costless. Direct costs include implementation cost,
reputation loss and potential punishment, etc. Agency theorists argue that tax
avoidance activities are also intertwined with corporate governance issues. Opaque tax

The authors appreciate the anonymous reviewers for their constructive comments and Nankai Business Review
International
suggestions. The study is supported by the National Natural Science Foundation of China Vol. 5 No. 1, 2014
(No. 70972146; No. 71372209), Humanities and Social Science Research Project of Ministry of pp. 25-42
q Emerald Group Publishing Limited
Education (09YJAZH078), Research Fund of Southwestern University of Finance and Economics, 2040-8749
and the Fundamental Research Funds for the Central Universities. DOI 10.1108/NBRI-10-2013-0037
NBRI planning activities camouflage managerial rent diversion and reduce firm value (Desai
5,1 and Dharmapala, 2006; Desai et al., 2007). Thus, whether a firm engages in tax
avoidance depends on whether benefits outweigh costs. This paper extends the tax
avoidance literature by examining the effect of tax avoidance on firm value in Chinese
unique institutional setting. We expect the relation of tax avoidance and firm value
varies with different levels of corporate governance.
26 Whether tax avoidance creates firm value is an important but under studied
research question. Current empirical evidence on investors’ reactions to tax avoidance
is mixed. The research on information content of tax avoidance suggests that income
tax expense is an indicator of corporation profitability. Tax avoidance reduces the
information content of income tax expense (Hanlon et al., 2005; Ayers et al., 2009). Desai
and Dharmapala (2009) find that the overall effect of corporate tax avoidance activities
on firm value is not significantly different from zero. The effect is positive only for
those firm-years with high levels of institutional ownership. They argue that corporate
tax avoidance has two competing effects on firm value. While it constitutes a wealth
transfer from government to shareholders, the agency conflicts between managers and
outside shareholders increase the likelihood of managerial diversion which is a minus
of firm value. Hanlon and Slemrod (2009) examine the market reactions to news about
tax shelter involvement. They find limited evidence on cross-sectional variations of
market reaction. Wang (2010) finds that investors place a value premium on tax
avoidance, but the price premium decreases as corporate opacity increases.
Presumably, the inconsistency of research findings may be partly due to different
selection of factors of interest, which have varying effects on current and future cash
flows and ultimate firm value, and partly due to differences in sample selections and
research perspectives. For the former reason, in particular, tax avoidance can impose
direct and indirect changes on current or future cash flows. For instance, direct
changes include that tax avoidance can increase cash flows through saving tax
whereas it is also associated with higher agency costs (increasing management
company-paid consumption, the building of “personal empire”, etc.). On the other hand,
aggressive tax avoidance complicates business transactions, leading to poorer
information transparency and lower firm value in an indirect way. Overall, the net
effect of tax avoidance on firm value is an empirical question. The emergence of
dominant influencing factor depends on specific business operating environment and
institutional background.
In this paper, we examine the effect of tax avoidance on firm value in Chinese
institutional environment because listed companies in China suffer serious agency
problems due to imperfect corporate governance mechanism. Thus, China is an
interesting setting to test the agency theory explanations of why tax avoidance does
not necessarily increase firm value.
Recent research suggests that information transparency, defined as the availability of
firm-specific information to those users outside publicly-traded firms, can function as
effective corporate governance to mitigate interest conflicts among stakeholders
(Armstrong et al., 2010). Prior studies show that information transparency can directly
contribute to economic performance by disciplining corporate insiders in better selection
of investments, more efficient management of assets in place, and reduced expropriation
of minority shareholders’ wealth (Bushman and Smith, 2003). Business decision making
relies on quality and quantity of information, thus information transparency could shift
current and future cash flows through influencing management decision making. Tax avoidance
Domestic research suggests that information transparency plays a key role in enhancing and firm value
the efficiency of management compensation contract (Wang and Zhang, 2009) and
shaping securities analyst forecast characteristics (Fang, 2007). Zhang et al. (2009) find
that there is a U-shaped relation between information transparency and firm market
value. In our case, we are wondering if information transparency plays a moderating
role in the relation of tax avoidance and firm value by alleviating agency severity. 27
With 20 years of development of Chinese capital market, listed companies have
made great efforts in building information disclosure, assessment and rating
mechanism. In this study, in addition to collecting a large sample of 4,104 firm-year
observations from 2001 to 2009, we also obtain annual information disclosure rating
index of listed firms compiled by Shenzhen Stock Exchange (SZSE), trying to examine
the interaction effects of tax avoidance and corporate transparency on firm value as
measured by Tobin’s q. We find that tax avoidance is negatively and significantly
associated with firm value. In addition, more tax avoidance activities are related to
higher agency costs, as measured by the ratio of period expenses to sales. Our
empirical results also show that tax avoidance behavior only enhances firm value in
more transparent listed companies. All three hypotheses are supported. Our unique
finding is inconsistent with conclusions based on US data. We argue that since firm
value is determined by the discounted value of current and future cash flows.
Intuitively, not only can tax avoidance change current or future cash flows directly, but
it also can shift cash flows indirectly by influencing management decision making. The
emergence of dominant effect depends on the equilibrium of multiple interacting forces,
including institutional arrangement and operating environment.
This paper contributes to the agency literature on corporate tax avoidance in
Chinese capital market setting. To our best knowledge, it provides the first piece of
evidence regarding shareholder reaction to Chinese listed firms’ tax avoidance and
offers insights into corporate governance. Our results show that, first, agency costs and
other non-tax costs are relatively high in China; second, investors in China do not place
value premium on tax avoidance for these kind of activities could cover management
rent-seeking behavior. Finally, information transparency can offset the negative
impact of tax avoidance on firm value, that is, tax avoidance is more likely to bring in
gains for transparent firms than opaque counterparts.
The rest of the paper proceeds as follows. Section 2 reviews literature and develops
empirical hypotheses. Sample selection and research design are presented in Section 3.
The empirical model and variable definition are presented in Section 4, and report the
empirical results and discussions in Section 5, and robustness checks are discussed
in Section 6.

2. Literature review and hypotheses development

Tax avoidance is broadly defined as the reduction in a firm’s explicit tax liabilities
(Dyreng et al., 2008). Under this broad definition, tax avoidance represents a continuum
of tax planning strategies where perfectly legal activities are at one end and more
aggressive activities would be closer to the other end (Hanlon and Heitzman, 2010).
Different disciplines differ in research perspectives regarding how and why corporate
income tax influences firm value. Finance literature focuses on the impact of debt-as-tax
shield on financing decisions (Kemsley and Nissim, 2002; Cooper and Nyborg, 2006).
NBRI Economists explore how illegal tax shield influences firm value (Hanlon and Slemrod,
5,1 2009) and how agency theory can account for tax avoidance on firm value (Desai and
Dharmapala, 2009). Accounting researchers tend to examine how tax avoidance would
shape financial statements and value relevance of taxation information (Hanlon et al.,
2005; Ayers et al., 2009). So far, there is lack of a comprehensive conceptual framework to
integrate research findings across disciplines. Traditionally, tax avoidance is viewed as
28 tax-saving method, and there is no other economic incentive other than saving tax.
By contrast, agency theorists argue that tax issues are interwoven with corporate
governance because of widespread agency problems. It is impossible to study tax
avoidance in a vacuum. In practice, the real purpose for management to engage in tax
avoidance is to complicate and obfuscate the transaction process, which provides
managers with shelter for self-serving behavior (Desai et al., 2007). Anecdotal evidence
also supports their view. In the 1990s, Enron leveraged structured financing transactions
to evade tax and manipulate earnings, which ultimately led to its failure.
Empirical research on the effect of tax avoidance on firm value is mixed. Desai and
Dharmapala (2009) find that tax avoidance is likely to increase value for well-governed
firms but it is not the case for poorly-governed firms. But other research findings are
inconsistent. Hanlon and Slemrod (2009) examine market reaction to application of tax
shield. On average, stock prices are falling at announcement, but the cross-section
variation is small and only significant to the retailing industry. Wang (2010) finds that
transparent firms are more aggressive to avoid tax than their opaque counterparts.
She also finds investors react positively to tax avoidance but firm value decreases as
transparency is decreasing.
How to account for the inconsistency of research findings? Theoretically, it is
presumed that tax avoidance behavior provides corporations with more free cash flow
either in the short run or in the long run, which directly increases firm value, and the
tax avoidance itself will shift cash flows indirectly by influencing management
decision making. Practically, the complexity and ambiguity of tax avoidance allow
managers to pipe the gains into themselves, which would reduce current and future
cash flows. In addition, according to classic agency theory, the free cash flow deriving
from tax avoidance would lead to the occurrence of company-paid consumption and
the building of “personal empire”, which will shrink future cash flow and decrease firm
value. Moreover, aggressive tax avoidance behavior is associated with administrative
punishment and subsequent reputation loss, which also decreases future cash flow and
firm value. Other indirect effects of tax avoidance include opaque financial information
(Balakrishnan et al., 2011), increasing probabilities of earnings management (Desai,
2005; Frank et al., 2009) and rising cost of capital (Lambert et al., 2007). Overall, we
believe that the relation of tax avoidance and firm value is an empirical question.
The emergence of dominant effect is dependent on a variety of factors, including the
institutional arrangement and operating environment, and the ultimate impact is the
equilibrium result of all involving forces.
Domestic empirical studies are primarily focused on tax avoidance behavior
determinants. For example, Wu (2009) examines the effects of state ownership and
favorable tax treatment on corporate tax liabilities. He finds that corporate tax
liabilities increase with the proportion of state ownership, and state ownership imposes
a heavier tax burden on firms without favorable tax treatment than firms with
favorable tax treatment. Zeng and Zhang (2009) argue that in districts with strong
taxation enforcement, the agency costs will be lower, and the tunneling and related Tax avoidance
party transactions will be fewer for majority shareholders, thus they believe taxation and firm value
enforcement can function as an external corporate governance mechanism. Li and Xu
(2013) find that enterprises with more political connections engage in more tax
avoidance behavior. Current Chinese literature could not explain why corporate tax
avoidance behavior differs, which is the exact void we are trying to fill.
As far as Chinese institutional environment is concerned, Chen and Zhu (2007) 29
conclude that the governance mechanism of Chinese listed firms has obvious
drawbacks, such as government intervention, poor investor legal protection,
controlling of major shareholders, loose supervision from state-owned banks and the
absence of external CPA governance. These flaws intensify two kinds of agency
problems. One is between shareholders and managers, and the “owner absence” causes
more severe agency problems in China; the other is between controlling shareholders
and minority shareholders. The controlling shareholders can dominate personnel
arrangements for board of directors and top management, and engage tunneling
through related party transaction. Jiang et al. (2010) find that tunneling has tax effect
as well, and it leads to firm value loss in the long run. Zeng and Zhang (2009) suggest in
areas with strong taxation enforcement, controlling shareholder is less likely to
expropriate assets and conduct related party transactions. They view taxation
enforcement as corporate governance mechanism. Using financial data of large and
medium-sized enterprises released by the Bureau of National Statistics, Zheng et al.
(2013) examine the corporate governance issues of non-listed firms. Their research
suggests that the improvement of the external legal environment significantly reduces
agency costs for non-listed firms, and taxation enforcement can partially serve as
corporate governance. As for the information content of tax expense, corporate income
tax expense can be viewed as an indicator of profitability (Chen and Yuan, 2004) and
has explanatory power of annual stock return (Wang and Dai, 2013).
Given Chinese institutional setting, the agency perspective may better explain the
relation between tax avoidance and firm value. H1 and H2 are put forward as follows:
H1. Ceteris paribus, tax avoidance behavior is negatively associated with firm
value.
H2. Ceteris paribus, tax avoidance behavior increases corporate agency costs.
Based on agency perspective on tax avoidance, firm governance is an important
determinant of the valuation of purported corporate tax savings. The direct effect of
tax avoidance is to increase the after-tax value of the firm, and these effects are
potentially offset, particularly in poorly governed firms, by increasing opportunities
for managerial rent diversion. Thus, the net effect on firm value should be greater for
firms with stronger governance institutions.
The foregoing analysis illustrates that information transparency interacts with tax
avoidance. Facing the threat of severe agency problems, information transparency
helps to mitigate agency conflicts among all stakeholders (Armstrong et al., 2010), to
adjust market value by shifting current and future cash flows through changing
management decision making (Lambert et al., 2007), and to discipline corporate
insiders in better selection of investments, more efficient management of assets in
place, and less expropriation of minority shareholders’ wealth (Bushman and Smith,
2003). On the other hand, transparency makes the business operations more revealing
NBRI to government, weakening the capability of avoiding tax. Hence, information
transparency is a well-suited variable to test the propositions of agency theory.
5,1 Transparency and openness are challenging to Chinese companies. Studies based on
China indicate that information transparency can improve the manager compensation
contract efficiency (Wang and Zhang, 2009), and shape securities analysts’ forecasting
characteristics (Fang, 2007). Zhang et al. (2009) argue that information transparency is
30 a double-edged sword, and there is a U-shaped relationship between information
transparency and firm market value. We expect that information transparency
moderates the relation of tax avoidance and firm value. H3 is proposed as follows:
H3. Relative to opaque counterparts, tax avoidance increases firm value for
transparent firms.

3. Sample selection and research design

(1) Sample selection
Our sample consists of firms that were listed on the SZSE over the period 2001-2009,
primarily because the information disclosure rating index of SZSE started from 2001
and only SZSE provides such disclosure rating index for firms listed in SZSE.
We exclude target firms in the financial industry since they have unique accounting
requirements and regulatory environment. We obtain a sample of 4,104 unique
firm-year observations. Financial accounting data is obtained from CSMAR database,
and tax rate data are sourced from RESSET financial research database.

(2) Measures of tax avoidance

In accounting literature, there is a lack of consensus on tax avoidance measure.
Generally, tax avoidance can be measured from three dimensions, and each measure
captures different aspects of the construct. The first two are based on book-tax
differences (BTD). We calculate the Manzon and Plesko (2002) BTD as follows:
Current Income tax ¼ Income tax expense
þ ðEnding deferred income tax liabilities
2 Beginning deferred income tax liabilitiesÞ
2 ðEnding deferred income tax assets
2 Beginning deferred income tax assetsÞ
BTD ¼ Profit before tax 2 Minority shareholder interests
2 ðCurrent Income tax expense=tax rate
2 Changes in the amount caused by making up losses for prior periodsÞ

The second way to measure tax avoidance is proposed by Desai and Dharmapala
(2006). This measure focuses on BTD that cannot be explained by variations in total
accruals. We denote this measure by TS as follows:
BTDi;t ¼ b1 TAi;t þ mi þ 1i;t
TS i;t ¼ mi þ 1i;t
where:
TA ðTotal accrualsÞ ¼ Total income 2 Cash flows from operating activities
Both measures are widely adopted in following research, such as Chen et al. (2010). Total Tax avoidance
book-tax gap reflects both temporary and permanent BTD in tax avoidance; however, it
makes no distinction between real operating activities and tax shelter transactions, and
and firm value
this gap is influenced by corporate earning management as well. To reduce the impact of
earning management, Desai and Dharmapala (2006) construct an empirical measure of
corporate tax avoidance – the component of the book-tax gap not attributable to
accounting accruals. These two indicators can complement each other. 31
Recent studies adopt firms’ effective tax rates (ETRs) to measure tax avoidance as
well. However, ETR do not distinguish the difference among tax avoidance,
government tax preference, or taxation lobbying activities (Hanlon and Heitzman,
2010). In China, local governments adopt various tax preference policies to attract
investments[1], which lead to lower effective rate than statutory rate. Thus, using
effective rate to measure tax avoidance in China could be misleading. Chinese listed
companies disclose actual statutory tax rate (e.g. 24, 15, and 7.5 percent) in the notes
to financial statements, so it is more accurate to measure tax avoidance using the
difference between actual statutory tax rate and effective tax rate. However, this
indicator may also be affected by different tax rates applied to parent company and
its subsidiaries, especially different consolidation rules for book and tax purposes. The
greater the difference is, the higher the degree of tax avoidance is. Our ETR values
are truncated within 0-1, and the actual statutory tax rate is obtained from RESSET
database. We denote the difference between ETR and adaptable tax rate by ETR_D as
follows:

ETR ¼ Income tax expense=Pre-tax income; ETR [ ½0; 1

ETR_D ¼ Actual statutory tax rate 2 Effective tax rate

It is worth noting that, rather than focusing on extreme tax-shielding transactions, we
aim to examine the general impact of tax avoidance on firm value, and thus adopt a
broad definition of tax avoidance which is suitable to our research objectives.

(3) Measures of information transparency

Information transparency plays a central role in the efficient allocation of resources in
the economy. SZSE started rating the information disclosure level of public firms listed
on SZSE since 2001. Tracking the information disclosure behavior of each listed firm
in one year, SZSE annually evaluates the information disclosure features in terms of
compliance, accuracy, timeliness and completeness, and ranks each firm at four levels
classified as excellent, good, acceptable and unacceptable. Consistent with recent
studies, we employ the annual rating by SZSE as the proxy variable of information
transparency. Wang and Zhang (2009) and Fang (2007) indicate information
transparency can improve the manager compensation contract efficiency, and play an
important role in reducing the information asymmetry and lowering agency cost by
using the SZSE information transparency ranking in the Chinese capital market.

4. Empirical model and variable construction

In the preceding analysis, we raise three questions: would tax avoidance decrease
values for firms with poor corporate governance? If it is the case, is it because high
agency costs exist in poorly-governed firms? Would information transparency provide
NBRI a buffer for declining firm value resulted from tax avoidance? To shed light on these
5,1 questions, three models are specified as follows, corresponding to three hypotheses:

qi;t ¼ a0 þ a1 TaxAggi;t þ a2 PPE i;t þ a3 DEBT i;t þ a4 ROAi;t þ a5 SIZE i;t

þ a6 NOLi;t þ a7 GROWTH i;t þ a8 BETAi;t þ a9 YEARi;t þ 1i;t ð1Þ

32 AgencyCost i;t ¼ a0 þ a1 TaxAgg i;t þ a2 PPE i;t þ a3 DEBT i;t þ a4 ROAi;t

ð2Þ
þ a5 SIZE i;t þ a6 GROWTH i;t þ a7 YEARi;t þ 1i;t

qi;t ¼ a0 þ a1 TaxAggi;t þ a2 Transi;t þ a3 ðTaxAggi;t *Transi;t Þ þ a4 TransSQi;t

þ a5 PPE i;t þ a6 DEBT i;t þ a7 ROAi;t þ a8 SIZE i;t þ a9 NOLi;t ð3Þ
þ a10 GROWTH i;t þ a11 BETAi;t þ a12 YEARi;t þ 1i;t

Following Zhang et al. (2009), we add a quadratic term of Trans in model (3) given the
“U-shape” relation of information transparency and firm value for Chinese listed
firms. In all three models, where a0 refers to constant interception, a1-a12 are
coefficients, 1 represents residual error.

Dependent variables
Tobin’s q (q) is used to represent firm value. Since there are two classes of shares in
Chinese listed companies, tradable shares and non-tradable shares, we adopt an
average discount factor 0.45 for non-tradable shares according to Yang et al. (2008) and
define Tobin’s q as follows:

q ¼ ðMarket value of tradable shares

þ Market value of non-tradable shares*0:45
þ Book value of liabilitiesÞ=Total assets:

Following Zheng et al. (2013), we use two ratio variables to measure agency costs: the
ratio of sales to total assets (STA), and the ratio of period expenses to sales (OETS):

STA ¼ Sales=Total assets

OETS ¼ ðSelling expense þ General administrative expense

þ Financing expenseÞ=Sales

Independent variables
TaxAgg is the tax avoidance variable, and we use three ways to measure tax
avoidance: BTD, TS and ETR_D as defined above. We expect a negative coefficient a1.
Trans is the proxy viable for corporate transparency. This ordered variable is coded
as 4, 3, 2 and 1 for excellent, good, acceptable and unacceptable rating based on SZSE
assessment of corporate information disclosure level.
TaxAgg*Trans is the interaction term of tax aggressiveness and transparency to
examine the moderating role of accounting information quality on tax avoidance and
firm value, and we expect a positive coefficient a3 for this interaction.
Control variables Tax avoidance
We include firm size (SIZE), return on assets (ROA), fixed assets (PPE), capital and firm value
structure (DEBT), loss carryforwards (NOL), sales growth rate (GROWTH), and risk
(BETA) in the regression model as control variables because prior studies show that
they are related to firm value (Desai and Dharmapala, 2009). Year dummy is also
included to control for year fixed effects. All variables (not including TS, Trans,
BETA) are winsorized at the 1 and 99 percentiles. The control variables are defined as: 33
PPE ¼ (Net PP&E þ Net investment in real estate)/Beginning total assets.
DEBT ¼ (Short term loans þ Notes payable þ Long term
liabilities[2])/Beginning total assets.
ROA ¼ Total profits/Beginning total assets.
SIZE ¼ LN (Total assets).
GROWTH ¼ (Current operating revenue 2 Prior operating revenue)/Beginning
operating revenue.
NOL ¼ Losses carryforwards/Beginning total assets.
BETA ¼ Stock market risk, sourced from CSMAR database.
YEAR ¼ Year dummy variable.

Estimation method
We expect that the level of tax avoidance varies across years and sectors of the
economy. To capture these effects, we adjust the standard errors for heteroskedasticity
and time-series correlation by using robust standard errors clustered at the firm level
(Petersen, 2009). We also use regression with Driscoll-Kraay standard errors, and we
use fixed effect model following the Hausman test result (x 2 ¼ 153). Most corporate
finance studies suffer endogeneity issues (Roberts and Whited, 2011), thus fixed effect
model is employed to alleviate the concern of endogeneity.

5. Empirical results and discussions

The descriptive statistics of main variables of interest are reported in Table I. The
mean and median of Tobin’s q are 1.782 and 1.397, respectively, whereas the mean and
median of BTD are 2 0.009 and 2 0.002, respectively. These numbers indicate that in
Chinese institutional environment the accumulated BTD are negative as opposed to
positive BTD based on US data. The result is similar to Tang and Firth (2011),
suggesting that tax law is more conservative on expense recognition than accounting
principles in China. The mean and median values for TS are 0 and 0.006, respectively.
As for the residual error of fixed effect estimation, it cannot be viewed as the tax
avoidance amounts during various years, and it properly reflects the changes of
tax avoidance activities related to time variables (Desai and Dharmapala, 2006). The
mean and median values of ETR_D are 2 0.051 and 0.01, while the mean and median
values of Trans are 2.697 and 3, indicating that more than half sample firms achieve
“good” information disclosure rating.
Table II presents correlations among the main variables of interest. Correlations
among three tax avoidance measures are significant at the 0.05 level. BTD is positively
NBRI
Variable Obs. Median Mean Std 25% 75%
5,1
q 4,104 1.397 1.782 1.148 1.081 2.031
BTD 4,104 20.002 20.009 0.104 2 0.030 0.020
TS 4,104 0.006 0.000 0.102 2 0.025 0.031
ETR_D 4,104 0.010 20.051 0.294 2 0.076 0.122
34 Trans 4,104 3.000 2.697 0.696 2.000 3.000
PPE 4,104 0.309 0.343 0.202 0.009 0.078
DEBT 4,104 0.299 0.321 0.224 0.163 0.441
ROA 4,104 0.037 0.039 0.097 0.009 0.078
SIZE 4,104 21.092 21.175 1.036 20.481 21.801
GROWTH 4,104 0.128 0.214 0.588 2 0.031 0.312
NOL 4,104 0.000 0.063 0.181 0.000 0.014
BETA 4,104 1.027 0.997 0.246 0.876 1.149
STA 4,104 0.510 0.628 0.473 0.317 0.787
OETS 4,104 0.154 0.256 0.439 0.010 0.248
Table I. Notes: This table describes the variables used in this study; all variables (not including TS, Trans and
Descriptive statistics BETA) presented in this table are winsorzied at the 1 and 99 percentiles; the sample contains 4,104 firm-
of variables of interest year observations from 2001 to 2009

correlated with TS and ETR_D, with correlation coefficients 0.977 and 0.271,
respectively. ETR_D is positively correlated with BTD and TS, with correlation
coefficients 0.271 and 0.240, respectively. It confirms that these measures capture
different aspects of tax avoidance construct. Results below are similar to those based
on US data (Chen et al., 2010; Wang, 2010). q is negatively and significantly correlated
with BTD and TS, indicating that tax avoidance is associated with the decrease in firm
value. The correlation coefficients of other control variables are below 0.4, showing
that there is no obvious multicollinearity of these variables. The correlation between
Trans and ETR_D are 0.140, suggesting that transparent firms are more tax
aggressive than their opaque counterparts.
The relations of tax avoidance and firm value are tabulated in Table III. Overall, firm
value is negatively associated with tax avoidance, with significant coefficients of three tax
aggressiveness metrics 20.338 (t ¼ 22.90), 20.250 (t ¼ 22.18) and 20.128 (t ¼ 23.04)
at 1 percent level. Thus, investors in China react negatively to tax avoidance as opposed
to American counterparts’ positive reactions (Desai and Dharmapala, 2009; Wang, 2010).
It is interesting to dig into this finding. Presumably, high agency costs might give
rise to this phenomenon. The relations of tax avoidance and agency costs are reported
in Table IV. In panel A, agency cost is measured as STA. The higher the ratio is, the
lower the agency cost is. Three tax avoidance metrics are negatively related to STA,
with coefficients 2 0.211 (t ¼ 2 5.59), 2 0.188 (t ¼ 2 5.06) and 2 0.113 (t ¼ 2 0.91).
Except for ETR_D, the other two exhibit significance at the level of 1 percent,
suggesting that more tax aggressive firm generates higher agency costs. Panel B also
verifies the results presented in Panel A. Three tax avoidance measures are positively
and significantly associated with agency cost. Our H2 is supported. Table IV indicates
that because of Chinese unique ownership structure and institutional environment, the
conflicts of interest existing between controlling shareholder and minority
shareholders might lead to exceptionally higher agency costs, which may account
for the inconsistent finding of China. Generally, all sorts of costs, including agency
 q BTD TS ETR_D Trans PPE DEBT ROA SIZE GROWTH NOL

q
BTD 20.045
TS 20.052 0.977
ETR_D 0.039 0.271 0.240
Trans 20.064 0.077 0.039 0.157
PPE 20.135 0.052 0.076 0.099 0.086
DEBT 20.089 2 0.006 20.009 2 0.027 20.052 0.211
ROA 0.073 0.358 0.249 0.342 0.359 0.155 20.108
SIZE 20.411 0.101 0.084 0.035 0.252 0.194 0.209 0.258
GROWTH 0.011 0.071 0.048 0.100 0.073 0.102 0.213 0.313 0.077
NOL 0.346 0.049 0.081 0.017 20.206 2 0.092 0.171 2 0.239 20.348 0.054
BETA 20.230 20.029 2 0.012 20.148 20.083 2 0.065 0.008 2 0.228 20.059 20.125 2 0.124
Notes: The numbers in italic is insignificant at: level of 5 percent and other correlation coefficients are significant at: level of 5 percent
Tax avoidance
and firm value

variables of interest
Correlations of
35

Table II.
NBRI
Fixed effects Fixed effects Fixed effects
5,1 (TaxAgg ¼ BTD) (TaxAgg ¼ TS ) (TaxAgg ¼ ETR_D)
Coefficient t-value Coefficient t-value Coefficient t-value

Intercept 15.186 * * * 22.12 15.244 * * * 22.19 15.460 * * * 22.67

TaxAgg 20.338 * * * 2 2.90 2 0.250 * * 22.18 20.128 * * * 2 3.04
36 PPE 20.326 * * * 2 3.11 2 0.318 * * * 23.04 20.307 * * * 2 2.93
DEBT 20.002 2 0.02 2 0.005 20.06 0.006 0.07
ROA 0.581 * * * 3.61 0.496 * * * 3.19 0.563 * * * 3.56
SIZE 20.595 * * * 2 17.76 2 0.597 * * * 217.82 20.608 * * * 2 18.25
GROWTH 20.003 2 0.15 2 0.001 20.03 20.001 2 0.03
NOL 0.491 * * * 5.06 0.468 * * * 4.81 0.416 * * * 4.56
BETA 20.650 * * * 2 12.73 2 0.652 * * * 212.77 20.665 * * * 2 13.05
YEAR Yes Yes Yes
n 4,104 4,104 4,104
Table III. R2 0.5428 Within 0.5423 Within 0.5429 Within
The relation of tax
avoidance and firm value Note: Significant at: *10, * *5 and * * *1 percent levels

Fixed effects Fixed effects Fixed effects

(TaxAgg ¼ BTD) (TaxAgg ¼ TS ) (TaxAgg ¼ ETR_D)
Coefficient t-value Coefficient t-value Coefficient t-value

Panel A DV ¼ STA
Intercept 2.041 * * * 9.63 2.041 * * * 9.62 2.007 * * * 9.41
TaxAgg 20.211 * * * 2 5.59 2 0.188 * * * 25.06 20.013 2 0.91
PPE 20.202 * * * 2 5.58 2 0.198 * * * 25.48 20.190 * * * 2 5.25
DEBT 20.198 * * * 2 7.38 2 0.202 * * * 27.52 20.207 * * * 2 7.66
ROA 0.454 * * * 8.26 0.412 * * * 7.76 0.359 * * * 6.58
SIZE 20.070 * * * 2 6.84 2 0.070 * * * 26.82 20.068 * * * 2 6.62
GROWTH 0.100 * * * 14.42 0.101 * * * 14.60 0.101 * * * 14.64
YEAR Yes Yes Yes
n 4,104 4,104 4,104
2
R 0.2449 Within 0.2436 Within 0.2381 Within
Panel B DV ¼ OETS
Intercept 2.238 * * * 7.03 2.226 * * * 6.99 2.160 * * * 6.80
TaxAgg 0.122 * * 2.15 0.155 * * * 2.78 0.110 * * * 5.09
PPE 0.128 * * 2.35 0.127 * * 2.35 0.120 * * 2.22
DEBT 0.232 * * * 5.75 0.233 * * * 5.78 0.231 * * * 5.74
ROA 21.806 * * * 2 21.85 2 1.798 * * * 222.58 21.878 * * * 2 23.10
SIZE 20.095 * * * 2 6.14 2 0.094 * * * 26.11 20.091 * * * 2 5.88
GROWTH 20.118 * * * 2 11.41 2 0.119 * * * 211.47 20.118 * * * 2 11.45
YEAR Yes Yes Yes
Table IV. n 4,104 4,104 4,104
The relation of tax R2 0.2384 Within 0.2436 Within 0.2381 Within
avoidance and
agency costs Note: Significant at: *10, * *5 and * * *1 percent levels

costs, outweigh the benefits gained by tax avoidance in China, which further reduces
firm value through shrinking current and future cash flows.
Information transparency plays a central role in mitigating agency conflicts
among stakeholders. Since business decision making depends on the quality and
quantity of information, information transparency can indirectly shift current and Tax avoidance
future cash flows by influencing business decision making. It is well-known that cash
flow is a key determinant of firm value. Following the logic of “information-cash
and firm value
flow-firm value”, it is important to examine the role played by information transparency.
Table V reports the results of relations among tax avoidance, information transparency
and firm value. The coefficients of Trans and TransSQ are significant at 1 percent level.
The results are consistent with Zhang et al. (2009), indicating a “U-shape” relationship 37
between information transparency and firm market value. The coefficients for
interaction term of tax avoidance and information transparency are 0.603, 0.557 and
0.072, respectively. Except for ETR_D, BTD and TS are consistent with expectations,
both significant at 1 percent level (with t-values 4.38 and 3.95, respectively). The positive
interaction term suggests that information disclosure transparency combining with tax
avoidance practice could enhance firm value, whereas firm value would be decreased if
tax avoidance is implemented in opaque firms.

6. Robustness checks
Using first-order differential method, we add lagged qi,t2 1 to represent prior period
firm value to control the series correlation of firm value and other relevant factors of q:
qi;t ¼a0 þ a1 DTaxAggi;t þ a2 Transi;t þ a3 ðDTaxAggi;t *Transi;t Þ þ a4 DPPEi;t
þ a5 DDEBTi;t þ a6 DROAi;t þ a7 DSIZEi;t þ a8 DNOLi;t þ a9 DGROWTHi;t
þ a10 DBETAi;t þ a11 qi;t21 þ a12 YEARi;t þ 1i;t
ð4Þ
The results presented in Table VI are consistent with Table V. The first-order
differential variables reflecting changes in tax avoidance DBTD and DTS are negatively
and significantly related to firm value at 10 percent level (2 1.277, t ¼ 2 3.34; 2 0.455,

Fixed effects Fixed effects Fixed effects

(TaxAgg ¼ BTD) (TaxAgg ¼ TS ) (TaxAgg ¼ ETR_D)
Coefficient t-value Coefficient t-value Coefficient t-value

Intercept 15.571 * * * 22.42 15.669 * * * 22.54 15.814 * * * 22.82

TaxAgg 21.752 * * * 2 5.15 21.570 * * * 2 4.48 20.296 * * 2 2.18
Trans 20.271 * * * 2 2.94 20.293 * * * 2 3.19 20.265 * * * 2 2.82
TaxAgg*Trans 0.603 * * * 4.38 0.557 * * * 3.95 0.072 1.30
TransSQ 0.054 * * * 3.12 0.058 * * * 3.32 0.054 * * * 3.06
PPE 20.328 * * * 2 3.14 20.323 * * * 2 3.10 20.299 * * * 2 2.86
DEBT 0.007 0.09 0.008 0.11 0.011 0.14
ROA 0.645 * * * 3.93 0.559 * * * 3.54 0.557 * * * 3.48
SIZE 20.599 * * * 2 17.95 20.602 * * * 2 18.01 20.611 * * * 2 18.36
GROWTH 20.004 2 0.22 20.003 2 0.13 0.001 0.03
NOL 0.535 * * * 5.51 0.513 * * * 5.26 0.420 * * * 4.60
BETA 20.646 * * * 2 12.70 20.649 * * * 2 12.76 20.663 * * * 2 13.03
YEAR Yes Yes Yes
n 4,104 4,104 4,104 Table V.
R2 0.5470 Within 0.5460 Within 0.5447 Tax avoidance,
information transparency
Note: Significant at: *10, * *5 and * * *1 percent levels and firm value
NBRI
OLS
5,1 OLS (TaxAgg ¼ BTD) OLS (TaxAgg ¼ TS ) (TaxAgg ¼ ETR_D)
Coefficient t-value Coefficient t-value Coefficient t-value

Intercept 20.623 21.62 2 0.624 2 1.61 2 0.634 2 1.60

DTaxAgg 21.277 * * * 23.34 2 0.455 * 2 1.95 2 0.163 2 1.22
38 Trans 0.195 1.05 0.020 1.06 0.020 1.09
DTaxAgg*Trans 0.394 * * * 3.35 0.357 * 1.91 0.030 0.43
DPPE 20.039 20.37 2 0.029 2 0.27 2 0.020 2 0.18
DDEBT 0.206 * 1.78 0.203 * 1.79 0.217 * 1.80
DROA 0.824 1.29 0.717 1.19 0.613 1.05
DSIZE 20.935 * * * 27.26 2 0.938 * * * 2 7.32 2 0.947 * * * 2 7.52
DGROWTH 0.011 0.58 0.015 0.81 0.021 1.13
DNOL 0.270 0.70 0.196 0.50 2 0.028 2 0.07
DBETA 20.324 * * * 23.68 2 0.326 * * * 2 3.61 2 0.340 * * * 2 3.72
qt2 1 20.242 * 21.81 2 0.243 * 2 1.81 2 0.242 * 2 1.82
YEAR Yes Yes Yes
n 3,287 3,287 3,287
R2 0.6282 0.6269 0.6263
Table VI. Notes: Significant at: *10, * *5 and * * *1 percent levels; to compute t-values, OLS regression adopts
Robustness checks the approach by Petersen (2009) to adjust clustering standard deviation of firm and year

t ¼ 2 1.95), suggesting aggressive tax avoidance fails to enhance firm value.

Meanwhile, except for DETR_D*Trans, the coefficients of DBTD*Trans and
TS*Trans are positive and significant at 10 percent level (DBTD*Trans ¼ 0.394,
t ¼ 3.35; TS*Trans ¼ 0.357, t ¼ 1.91), indicating more transparent firms engaging in
tax planning would add value premium to themselves.
In addition, replacing qi,t with qi,tþ 1 does not change regression results
substantially. Meanwhile, the results are not sensitive to different calculations of
Tobin q. The computation of non-tradable share value varies with market value or
book value; either way does not change results substantially. In unreported table, the
results are robust to the replacement of Tobin q with M/B ratio.
To address the impact of institutional change, we conduct robust tests on 2001-2007
and 2008-2009 subsamples, given the corporate income tax reform introduced in 2008.
China launched significant enterprise income tax reform in 2008 which eliminated
substantial tax credits for listed firms and increased overall corporate income tax
level. In this context, tax avoidance behavior varies for enterprises with differential
tax rate. Robust tests show that there is no substantial change for the main results,
indicating minor influence of institutional change and time on the variables of interest.
Taking the year of 2007, in which China’s GAAP converged with IFRS, as a cutoff point
and splitting the whole sample into two subsamples, we draw similar conclusions.
Finally, our results remain robust even after controlling geographical differences
and ultimate ownership characteristics. To address the concern of endogeneity, a series
of alternative treatments are conducted, including fixed effects of panel data, first-order
differential, lagged variables and 2SLS. Nevertheless, we still cannot eliminate the
threat of endogeneity. Thus, we believe that there are associations to some extent
among tax avoidance, information transparency and firm value, and the exact
cause-and-effect relationship cannot be determined.
7. Conclusions and implications Tax avoidance
This paper examines whether tax avoidance behavior enhances firm value in Chinese and firm value
institutional setting. While the traditional view of corporate tax avoidance suggests that
shareholder value should benefit from tax avoidance activities, an agency perspective on
corporate tax avoidance provides a more nuanced prediction. Specifically, corporate
governance should be an important determinant of the valuation of purported corporate
tax savings. While tax avoidance per se should increase the after-tax firm value, this 39
effect is potentially offset, particularly in poorly governed firms, by increasing
probabilities of rent diversion provided by tax shelters. China is a country where the
unique institutional arrangements make corporate agency problems more severe than
most western countries. Using the data of Chinese listed companies for the period
2001-2009, we find that the increases in tax avoidance tend to reduce the level of firm
value. Tax avoidance behavior does more harm than good to investors in China. After 20
years of development of the Chinese capital market, listed companies have made great
efforts in improving corporate governance, including enhancing information disclosure
transparency. In this paper, we also find that corporate transparency interacts with tax
avoidance and acts as the moderator variable between tax avoidance and corporate
value. The negative relation between tax avoidance and firm value is attenuated in
well-governed firms. Taken as a whole, investors in China do not place value premium
on tax avoidance because this kind of activity could camouflage manager rent-seeking
behavior. In other words, investors in China downplay the significance of tax avoidance,
although information transparency could soften their negative tone.
One limitation of our study is that we focus on examining the general economic
consequences of tax avoidance in the Chinese institutional context, and we do not explore
how specific institutional characteristics shape domestic corporate tax avoidance
behavior, so we leave these questions for future research. The policy implications of this
paper indicate that the characteristics of the taxation system in one country, such as the
structure of rates and the status of enforcement, will shape managerial actions as well as
the severity of agency problems. Tax avoidance does not simply represent wealth
transfer from government to shareholders, but it also means part of gains might be piped
into self-serving managers. Hence, improving corporate governance and strengthening
tax enforcement can bring in more tax revenue and shareholder wealth.

Notes
1. In China, National Taxation Bureau (Guoshuiju) and provincial bureaus (Dishuiju) are
responsible for collecting central taxes and local taxes separately. Right now, corporate
income tax is classified as a central tax and thus is collected by the National Taxation
Bureau and its branches in all provinces. Tax policies are widely used in local governments,
especially in coastal regions of China to attract more investments, such as establishing
economic development zone and granting tax credit and preference for high-tech firms, etc.
2. If the amount of long-term liabilities is zero, we use non-current liabilities instead.

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