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An examination of labor unions and firm’s tax ethical behavior in the USA

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Abstract

Prior research finds that firms with strong business ethics are less likely to be tax aggressive. Labor union is one of the key stakeholders influencing firm’s tax aggressive behavior, whereas the bargaining process between labor union and firms exhibits ethical dilemma. Although industry-wide labor union coverage is commonly used in prior study to explore the monitoring role of labor unions in constraining management’s aggressive financial and tax decisions of their associated firms, we argue that firm-specific labor unions, which represent a different bargaining power of the employees, do play an important role in determining firms’ tax ethical decisions. Specifically, we examine whether and how the firm-specific labor union coverage impacts firms’ tax aggressiveness decisions over and above industry-wide labor union coverage. We hypothesize and find that firm-specific labor unions influence the associated firms to be more tax aggressive, which results in higher levels of residual cash flows. We also find that industry-wide labor unions influence the associated firms to be less tax aggressive, which is consistent with prior findings. We perform further analyses and find that the results are more pronounced for the firms with greater industry-wide labor unions representation. These results demonstrate that the inclusion of and interaction between the firm-specific and industry-wide labor unions matter in determining corporate’s tax aggressiveness decisions, which highlight firm’s ethical perplexity between tax savings and social commitments.

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Notes

  1. The “Trickle-Down Theory” is further discussed in the Literature Review and Hypothesis Development section.

  2. Employees are always the most valuable resources in any organization and they can affect the performance and success of an organization. When workers find that they are not fairly treated, they will ask their labor unions to represent them and negotiate with their employers on their behalf. A case on how labor unions bring significantly negative economic and financial consequences to the associated firm can be traced back to the 40-day strike organized by the port workers in Hong Kong on 28 March 2013 and being described by the press as “Hong Kong’s largest industrial actions for six years.” During the strike, cargos cannot be loaded or unloaded, which causes large financial and economic losses.

  3. Hanlon and Thornton (2017) argue that tax cuts do not create any job opportunities though.

  4. Common types of monetary penalties suggested by Chyz et al. (2013) include (1) IRS penalties, (2) IRS rejections, (3) interests on back-taxes, and (4) possible litigation costs.

  5. Costs related to tax aggressive behavior include (1) costs incurred due to tax implementation, (2) reputational loss, (3) costs caused by reduced financial reporting transparency, and (4) costs as a result of increased organizational complexity.

  6. The term collective bargaining appears very frequently in labor union literature (Connolly et al. 1986; Craypo 1986; Bronars and Deere 1991; Chen et al. 2010; Chen et al. 2011; Cheng 2017; Chyz et al. 2013 etc.). Dau-Schmidt and Ellis (2010) find five factors that affect the collective bargaining power of labor unions in economic terms. The nature of the goods is the first factor and it is very important to consider whether the goods can be stockpiled when employees are on strike. The second factor is related to whether or not low-skilled workers can continue to produce the goods when the skillful workers are on strike, as described as the production technology. The third factor is related to the economic condition in the market, i.e. demand of goods and supply of qualified workers during strike. The fourth factor is related to the structure of the firm and the size of the bargaining, i.e. big labor unions against small employers or the other way round. The fifth factor is related to the commitment of workers to the collective action, i.e. will workers cross the picket line?

  7. Foreign private issuers of securities do not file 10-K reports but they file 6-K reports.

  8. We also include labo(u)r in the keyword list because labor is commonly used in American English while labo(u)r is more frequently used in other English-speaking countries.

  9. PREUTB = -0.004 + 0.011*ROA + 0.001*SIZE + 0.010*FOR_SALE + 0.092*R&D – 0.002*DISACC – 0.003*LEV + 0.000*MTB + 0.014*SG&A – 0.018*SALES_GR. Returns on assets (ROA) is calculated by dividing operating incomes: [pre-tax earnings (Compustat data #170) – extraordinary items (Compustat item #192)] by sales (Compustat data #12). Size (SIZE) is the log value of total assets (Compustat data #6). Foreign sales (FOR_SALE) is a dummy variable that equals one for firm observations reporting foreign income (Compustat data #273). Research and development (R&D) is the total research and development expenses (Compustat data #46) scaled by total lagged assets (Compustat data #6). Absolute value of discretionary accruals (DISACC) is derived by using the performance-adjusted modified Jones model. Leverage (LEV) is the sum of total long-term debt (Compustat data #9) and total debt in current liability (Compustat data #34), scaled by total lagged assets (Compustat data #6). Market-to-book ratio (MTB) is the market-to-book ratio at the year end. It is the quotient of market value of equity and book value of equity. Market value of equity is calculated by multiplying price close – annual (fiscal) (Compustat data #199) and common shares outstanding (Compustat data #25) while book value of equity is the total common / ordinary equity (Compustat data #60). Selling, general and administrative expenses (SG&A) is the total selling, general and administrative expenses (Compustat data #132) scaled by total lagged assets (Compustat data #6). Sales growth (SALES_GR) is the change in net sales / turnover (Compustat data #12) scaled by total lagged assets (Compustat data #6).

  10. SHELTER = -4.86 + 5.20*BTD + 4.08*DISACC – 1.41*LEV + 0.76*AT + 3.51*ROA + 1.72*FI + 2.43*R&D. Book-tax difference (BTD) is the difference between the book income and the taxable income. Book income is the readily available book income from Compustat (Compustat data #170). Taxable income is the gross sum of two types of tax expenses including (1) current federal tax expense (Compustat data #63) and (2) current foreign tax expense (Compustat data #64). Following Wilson (2009), when the current federal tax expense is missing, we calculate such expense in the following way: [Total income taxes (Compustat data #16) – deferred taxes (Compustat data #50) – state income taxes (Compustat data #173) – other income taxes (Compustat data #211)]. Log of assets (AT) is the natural log of total assets (Compustat data #6). Foreign income (FI) is the total foreign pre-tax income (Compustat data #273) scaled by total lagged assets (Compustat data #6). Other variables are defined previously in footnote #8.

  11. We first download from Compustat for each firm observation, the six-digit North American Industry Classification System (“NAICS”) codes. We then convert these NAICS codes to Census Industry Codes (“CICs”), which are the identification codes used by the Union and Coverage Database where the industry-wide labor unions coverage (ILUR) can be found. We use the data from the Section 4 - “Union Membership, Coverage, Density, and Employment by Industry, 1983 – 2012.” Each firm observation, based on its CIC, is being categorized into different industry groups, and from each industry group, we can identify the ILUR within the period of 2003 to 2009.

  12. In this regard, 618 firm observations are excluded in the median calculation process, and the sample size available for these subsample tests is 2,346 firm observations.

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Acknowledgements

We appreciate the helpful comments from In-Mu Haw, Kevin Lam, along with seminar participants at The Hang Seng University of Hong Kong, City University of Hong Kong, and seminar participants at the 24th Annual Conference on Pacific Basin Finance, Economics, Accounting, and Management on the earlier draft of this paper

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  1. The Hang Seng University of Hong Kong, Office #748, Lee Quo Wei Academic Building, Hang Shin Link, Siu Lek Yuen, Shatin, Hong Kong

    Hong Weng (Lawrence) Lei

  2. College of Business, Stony Brook University, Stony Brook, NY, 11794-3775, USA

    Chansog (Francis) Kim

  3. City University of HongKong, 13-238, Lau Ming Wai Academic Building, Kowloon Tong, Hong Kong

    Raymond M. K. Wong

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Correspondence to Hong Weng (Lawrence) Lei.

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Lei, H., Kim, C. & Wong, R.M.K. An examination of labor unions and firm’s tax ethical behavior in the USA. Asian J Bus Ethics 9, 93–120 (2020). https://doi.org/10.1007/s13520-020-00101-y

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