Tax Enforcement as a Corporate Governance Mechanism: Empirical Evidence from China

Manuscript Type: Empirical Research Question/Issue: This study first measures tax enforcement efforts for 35 tax regions within China, then analyzes the role of tax enforcement as a corporate governance mechanism by examining whether regional tax enforcement efforts reduce two types of agency costs in Chinese listed firms. Research Findings/Insights: Using archival data from a pooled sample of 917 listed firms with total 3,668 observations from 2003 to 2006 in China, we find the following results: (1) regional tax enforcement efforts reduce corporate agency costs between shareholders and managers and agency costs between blockholders and minority shareholders; (2) by reducing two kinds of agency costs, tax enforcement efforts improve a firm's market performance; and (3) the governance role of tax enforcement efforts is more significant for state-controlled firms than for entrepreneur-controlled firms. Theoretical/Academic Implications: This study suggests that tax enforcement can act as a corporate governance mechanism. Tax authorities not only have the ability to increase national tax revenue, but also play a positive role in decreasing agency costs, including agency costs between shareholders and managers and those between block shareholders and minority shareholders. Practitioner/Policy Implications: This study offers a new insight to policy makers interested in transforming economies that corporate governance build-up should be multidimensional. Besides the traditionally internal governance mechanisms represented by boards of directors and external governance mechanisms represented by takeover markets, tax enforcement is also an important corporate governance mechanism. The enforcement power of tax authorities could be better utilized to supervise firm operations in emerging markets.