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CEOs and Tax Payment: Too Much Is More Than Enough (To Get You Fired)

by Fabio B. Gaertner Tuesday, April 18, 2017

In October 1999,The Wall Street Journal  featured an article on new Xerox head Richard Thoman: “CEO Finds Jam in Xerox Machine; What Successful Model Will He Copy?”

Within six months, Thoman was ousted. The Journal  later reported that mismanagement during Thoman’s tenure resulted in a 7 percent increase in Xerox’s reported effective tax rate (the amount of taxes a corporation pays divided by its pretax income).

Punny headlines aside, CEOs who saddle their firms with a higher effective tax rate might just be accelerating their own exit.

Fabio Gaertner

Fabio B. Gaertner, assistant professor of accounting and information systems

Along with James Chyz of the University of Tennessee, I looked at 1,459 incidences of forced turnovers from 1993 to 2006, weeding out those who exited voluntarily or left for other reasons. Forced CEO turnover represents a deliberate action by a firm’s board to steer the direction of the ship, an act that modifies a company’s direction, strategy, and leadership. We wanted to know what tax rates looked like before the ouster—including how firms stacked up against their peers—and if forced turnover increases only for firms with relatively low tax rates, or if it increases for firms with relatively high rates as well.

The answer is both. CEOs are forced out for paying too much tax and for paying too little tax. 

We found that CEOs of firms that pay high taxes relative to their peers are more likely to get canned. This is to be expected. Taxes represent a wealth transfer from shareholders to taxing authorities; tax planning is viewed as beneficial to shareholders since it results in higher cash flows and net income. Good tax planning on the part of CEOs increases the shareholders’ after-tax earnings.

However, the data suggests CEOs are also ousted for paying too little tax, although only after the implementation of the Sarbanes-Oxley Act of 2002, which was created to protect the public and shareholders from corporate fraud.

CEOs being fired for paying too little tax indicates that reputation costs—firms are worried about how they look to the public—constrict what companies are willing to do (like use a tax shelter, for example). This is good news! Multiple instances of the great frauds of the late ‘90s and 2000s (e.g., Tyco, Enron) were facilitated by tax avoidance vehicles put in place by management. Our evidence suggests that during this period of greater regulatory scrutiny no one wanted to come off as a poor corporate citizen.

It’s also interesting to see from our work what happens post-firing. Firms in the lower effective tax rate bracket face an increase in taxes—perhaps an unwinding of the former aggressive tax policy. Once the CEO is removed at firms paying higher taxes, the firms’ rates tend to lower and stabilize; replacement CEOs appear to move these firms’ effective tax rates closer to peers. 

Boards seem to believe CEOs can impact taxes and they will hold them accountable for tax performance, at least to some degree. Whether it’s spoken or inferred, firms appear to look to effective tax rates as an incremental performance metric for CEOs. Clearly, if that’s the case, our data suggests that CEOs engaging in too much or too little tax avoidance might be putting their jobs at risk. 

Read the paper “Can Paying ‘Too Much’ or ‘Too Little’ Tax Contribute to Forced CEO Turnover?”, which is accepted for publication in The Accounting Review.

Fabio B. Gaertner is an assistant professor in the Department of Accounting and Information Systems at the Wisconsin School of Business.