Tax-Savvy Executives

Courtesy of Tom Kubick, Yijun Li, and John Robinson

“Generally, the talent pool at lower levels—entry and staff levels—is still adequate, but the talent pool at the leadership level is extremely challenged. In some major markets, tax leadership jobs have stayed unfilled for up to a year because of an inability to find the skillset companies seek.”

–Jeff Ausnehmer, Deloitte Tax, LLP, featured in the CFO Journal by the Wall Street Journal [1]

In a forthcoming article in the Review of Accounting Studies, we investigate why firms include individuals with significant professional tax experience on their senior management team and the consequences associated with the presence of these tax-savvy senior executives.

We search the employment history of the individuals serving as senior managers from 1994 through 2014, as identified by BoardEx,[2] and identify a sample of 653 individuals in the U.S. executive labor market having significant tax experience. Such experience is derived from managing tax departments of private or public companies and tax practices in public accounting firms or tax law firms where the executive has performed tax-specific roles at the manager level or above (e.g., Tax Manager, Tax Partner, Director of Tax, Vice President of Tax, Chief Tax Officer, etc.). We refer to these individuals as “tax-savvy executives.”

Tax-savvy executives could be attractive to certain firms’ top management teams. For example, the detailed understanding of tax law and tax-related industry experience acquired by tax-savvy executives translates into a better command of the financial implications of operational and strategic decisions as well as financial reporting consequences. Carl Allegretti, Chairman and CEO of Deloitte Tax, LLP, once stated that: “Because the implications of tax affect the financial and strategic decisions of many organizations, tax issues are capturing the attention of C-suite executives and boards.” Such detailed contextual knowledge and experience provide tax-savvy executives with the ability to identify and integrate tax-saving opportunities into business strategies and translate these opportunities into improved financial results.

From an academic accountant’s perspective, we find tax-savvy executives interesting to study because of the “under-sheltering puzzle.” A significant number of companies appear to avoid taxes over long periods whereas other comparable firms consistently pay higher taxes. Furthermore, despite a growing literature stream arguing that innate managerial characteristics (sometimes referred to as “manager fixed effects” in the academic literature) affect corporate policies, there has been little attention devoted to investigating the decision to employ senior executives with prior professional experience and specialized expertise. Whether and how an executive’s previous professional tax expertise influences corporate business strategies, financial policies, or firm performance is also not well known in the academic literature.

We provide empirical evidence identifying the factors associated with the presence of a tax-savvy executive in the senior management team. We predict that tax burdens relative to industry peers, firm resources, recent financial performance, network connections, and geographic proximity to areas with larger concentrations of tax talent can have a meaningful impact on the likelihood of having a tax-savvy executive in the senior management team. Our results suggest that a firm is more likely to have a tax-savvy executive in the senior management team when the firm is larger or less profitable, has multinational operations, recent acquisition activity, or lower effective tax rates than its industry peers. Greater access to a pool of tax talent also increases the the chances of a firm having a tax savvy executive.

We also investigate whether the presence of tax-savvy executives in senior management is associated with subsequent financial performance. To address endogeneity concerns in this analysis, we use propensity-score matching to construct a sample of firms with similar observable characteristics. Specifically, we match firms that have recently hired tax-savvy senior executives to firms that have recently hired senior executives without tax experience. We find that firms led by tax-savvy senior executives subsequently exhibit reduced effective tax expense rates and pay lower cash tax rates compared to a control sample of otherwise comparable firms. On average, we observe hiring firms’ effective tax rates subsequently decline by 1.6 to 2.1 percentage points compared to matched control firms.

In additional analyses, we isolate a mechanism through which tax-savvy executives can lower their firm’s effective tax rate. Specifically, we observe that the lower subsequent effective tax rates associated with hiring tax-savvy executives are associated with increased usage of subsidiaries in tax haven countries and foreign jurisdictions. We also confirm that effective tax rates and their corresponding mechanisms (foreign subsidiaries in low tax jurisdictions) rebound after the departure of a tax-savvy senior executive. This latter result helps to rule out the possibility that the results are attributable to some unobserved event that is merely coincident with the presence of a tax-savvy executive.

These findings provide a better understanding of why some firms have tax experts in senior management positions, and the magnitude of the effect of professional expertise on tax outcomes. In particular, we document differences in firms’ ability and motivation to place tax experts in the senior management team. These differences include resources, connections, and tax rates relative to industry peers. These findings should also be informative to corporate boards, as well as stakeholders outside the senior management team, involved in making or analyzing employment decisions at the senior executive level.

 

[1] https://deloitte.wsj.com/cfo/2015/08/31/succession-planning-for-tax-leadership-why-it-matters-to-cfos/

[2] A commercial database used to identify top talent for executive placement and to enhance relationship mapping and business development.

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