Hui Li, Hao Shen, Bo Wang, and Haizhi Wang Managerial Finance, Vol. 51 No. 4, pp. 549-566

DOI: https://doi.org/10.1108/MF-09-2024-0706

What the paper is about

Some corporate directors also hold executive positions at commercial banks that lend to the firms whose boards they sit on. Because a bank bears the downside of a loan without sharing in the upside of a risky investment, these affiliated banker directors have reason to be more risk-averse than an ordinary board member, and earlier work has linked their presence to lower leverage, more conservative investment, and steadier stock prices. We ask whether that same influence extends to a specific accounting choice, corporate tax avoidance, which raises after-tax cash flow but carries legal, informational, and reputational risk if it draws scrutiny from tax authorities.

Using 43,992 firm-year observations from 5,601 firms between 1999 and 2016, matched from BoardEx, DealScan, and Compustat, we find that firms with at least one affiliated banker director show lower tax avoidance than firms without one, using both the cash effective tax rate and the permanent book-tax difference as measures. The relation survives an instrumental variable approach built on the geographic distance between a firm and its lending bank, holds when the sample is narrowed to directors from lead banks in a loan syndicate, and is stable across several alternative measures of both tax avoidance and the director relationship itself.

The negative relation is more pronounced in firms that depend more heavily on bank financing, whether measured by the absence of a credit rating or by sub-investment-grade status, and in firms facing tighter financial constraints, where the incentive to use tax avoidance to conserve cash is otherwise strongest.

We then trace three channels through which the relation appears to run. It is stronger in firms with weaker corporate governance, consistent with these directors acting as monitors. It is stronger in firms with wider bid-ask spreads and a higher probability of informed trading, consistent with the directors drawing on their banking background to police an otherwise opaque information environment. And it is stronger when the affiliated bank holds more loan market share, and so has more reputation at stake if the firm’s tax position is later challenged, a pattern we identify after correcting for the fact that these directors do not appear on boards at random.

Highlights

  • Firms with an affiliated banker director show significantly lower corporate tax avoidance.
  • An instrumental variable approach based on bank-firm distance supports a causal reading.
  • Bank-dependent and financially constrained firms show the largest effects.
  • Weak corporate governance and opaque information environments both amplify the effect.
  • The affiliated bank’s own reputational stake also shapes how far directors push back.