INTRODUCTION 1.1 Background to the Study
Taxes are a fundamental revenue source for governments the world over. They represent a recognized compulsory contribution by individuals and corporate entities towards governance, development and maintenance of physical infrastructure as well as a tool of bridging income inequities. They are also a means by which the social contract between the State and the citizenry is being nourished and facilitated (Christensen & Murphy, 2004). Taxes also happen to be the most important, sustainable and predictable source of public finance for almost all countries (Action Aid, 2013). Thus properly harnessing amounts collected via taxes is a major concern for governments.In assessing the extent to which a country has harnessed and financed its economy through taxation, an often used measure is the tax to GDP ratio. Scholars have however noted that the tax to GDP ratio for the developing world as a whole is relatively low when compared to what obtains in the developed economies. For instance, according to Fuest and Riedel (2009) the tax to GDP ratio for developing economies was on average approximately 12-15% as at 2005. Conversely, for the developed economies, the average for the same year was quoted as approximately 35%; a figure more than twice what obtained in the developing climes. More recent reports show some improvement in the ratio but given the potential the region has for increased tax revenue, the improvement has not been found to be impressive. For instance, a report by the International Tax Compact, ITC (2010), noted that while tax revenues in Organization for Economic Cooperation and Development (OECD) countries amounted to almost 36% of gross national income in 2007, the share in selected developing regions was estimated to be around 23% for Africa (in 2007) and 17.5% for Latin America (in 2004).Specifically focusing on Nigeria, as at January 2014, tax revenue to GDP ratio stood at 20% (Premium Times, 2014). However with the rebasing of Nigeria‟s GDP in 2014, which saw the country‟s GDP increase from N42.3 trillion to N80.3 trillion, making Nigeria Africa‟s largest economy, Nigeria‟s tax revenue to GDP ratio fell from 20 % to 12 %. Out of the said 12 %, only 4% was attributable to non-oil revenue. This led to a call by the then Minister of finance on the need for the taxing authorities to redouble their revenue generation efforts (Premium Times, 2014). This call by the minister as well as the assertion by Oxfam (2014) that widening income disparities are the second greatest worldwide risk in 2014, underscore the need to look deeper into the various sources of development finance, especially taxation. The highly volatile nature of oil revenue- which the Nigerian economy depends on to a large extent should, arguably, also serve as an added impetus towards looking for ways to better harness other revenue sources such as taxes.
In exploring how to better harness tax revenues, it has been documented world over that, two major activities; perpetrated by both individuals and corporations, have continued to represent a great threat to amounts of revenue collected through taxes. In addition, the said issues feature prominently in equity and efficiency related discourse. The duo of issues are tax evasion and tax avoidance. While both are aspects of tax non-compliance, the delineating feature between the two lies in the fact that tax evasion is deemed out rightly illegal while by definition tax avoidance is not. However notwithstanding the delineating line between the two, in advanced economies, the duo have been given serious consideration by their governments, through the relevant agencies. Furthermore, the two issues have sparked much research; ranging from investigating their determinants- both for individuals and for corporations examinations of the attendant consequences engendered by their continued flourish.
The question of what factors explain the ability of firms and corporations to avoid taxes is of particular interest to researchers. The reason for much of the focus on tax avoidance as opposed to tax evasion is because evasion as a criminal act has to be proven by court. Thus using the term avoidance is seen as less dyslogistic. In however considering corporate tax avoidance as a research issue, researchers such as Shackelford and Shevlin (2001) have earlier questioned the applicability of models of individual tax evasion and avoidance such as the Allingham and Sandmo (1972) framework in explaining and predicting corporate tax avoidance. They argued that the separation of ownership and control, a hallmark of corporate entities, means that existing individual tax non-compliance frameworks cannot adequately explain same for corporations. In furtherance of the argument, Slemrod (2004) stated that this same separation of ownership and control means that shareholders need the corporation to engage in some level of avoidance. Thus, ininvestigatingwhat factors explain tax avoidance by firms and corporations, earlier studies on corporate tax avoidance focused primarily on examining whether firm-specific characteristics such as size, leverage, growth, profitability,amongst others could explain the tax avoidance phenomenon for business entities (e.g., Gupta & Newberry, 1997). These earlier studies however failed to consider agency issues in their analyses. Pointing out why failing to do so is an anomaly, Desai and Dharmapala (2006, 2007) argued that since decisions about corporate tax avoidance are made by firm managers, then the analysis of such decisions is thus embedded in an agency framework.The agency framework is one that argues that managers are risk averse and self-serving in nature and that this risk averseness as well as self-serving nature means that managers will not typically act or make decisions in the best interest of owners. To ensure goal congruence between management and shareholders or owners, the framework suggests that managers should be both incentivized and monitored. Corporate governance mechanisms represent the means by which monitoring managers can be achieved. Corporate governance mechanisms can however be internal or external. The internal mechanisms are those that have to do with the efficacy of the board of directors in appropriately advising on and overseeing the design and implementation of business strategies that will ensure that managers maximize shareholder wealth. In addition, such internal mechanisms include the role that shareholders themselves play in ensuring goal alignment. Prescriptions that have to do in particular with size, independence, remuneration and financial expertise of the board have therefore featured prominently in the various codes of corporate governance that have been issued both nationally and internationally as guides to what constitutes “best practice†in oversight. On the other hand, external governance mechanisms include all other stakeholder monitoring. Therefore mechanisms such as government regulation, debt covenants, takeovers, financial analysts and the like are all aspects of external governance. Internal governance mechanisms have, in particular, been touted to be foremost amongst the monitoring mechanisms that can ensure goal alignment between owners and managers. This is thought to be so because the board of directors is responsible for the strategic direction of the company. Charting a course for effective tax management is one of such strategic direction. Therefore, like any other board room stratagem, managing taxes requires a laid down philosophy which is usually determined by the board; documented, communicated and implemented as overall corporate strategy (Erle, 2007). Thus, board related governance mechanism such as size, independence, and ownership, amongst others can arguably play a key role in determining a company‟s tax planning.Board size simply refers to the number of persons that constitute the board of directors of a corporate entity. The number of persons that constitute the board of directors is thought to influence the advisory capacity of the board as well as its monitoring effectiveness. However, what constitutes the optimal board size to achieve this effectiveness has been a subject of debate. While some argue that a large board is more desirable because the larger the number on the board the more the level of diversity, skill and expertise; others argue that larger boards stifle discussion, therefore smaller boards are more effective because communication within a smaller group is easier (Jensen, 1993). Given that managing the tax expense (tax avoidance) is thought to be beneficial for corporate owners, this study therefore finds it necessary to examine whether board size as an internal governance metric affects tax avoidance by deposit money banks (DMBs) in Nigeria. Board independence, the proportion of members of the board who are non-executive directors, is another internal governance metric that influences board oversight. For this reason the codes of corporate governance give it categorical mention. Empirical studies to date, are however yet to consistently document either significant associations or signs when relating board independence to corporate outcomes. The intuition that board independence can influence tax avoidance by DMBs is however appealing. This is because in relation to other firm performance metrics such as profitability and firm value, it has been argued that the independent judgments that non-executive directors can bring to bear on corporate outcomes enhances oversight. Whether this is so in relation to tax avoidance by Nigerian DMBs is however an empirical question that is yet to be examined.
Ownership structure dimensions such as having an individual with sizeable number of shares in a company (block shareholding), the level of managerial shareholding as well as the ownership of shares by other corporate bodies (institutional shareholding) are also regarded as key internal governance mechanisms that ought to provide effective oversight over management. This position arises from the fact that in the modern day corporation,which has a multitude of owners and whereby the manager is not an owner,the self-serving behavior of the manager needs to be checked. Therefore, agency theorists such as Jensen and Meckling (1976), Fama (1980) as well as Fama and Jensen (1983) have all posited that making the manager a co-owner and having concentrated ownership in the form of either a block holder or an institutional shareholder, or both, should give all such owners additional motivation to more regularly appraise management; thereby ensuring goal convergence. Tax avoidance is, in most instances, likely to benefit the shareholders. Therefore, the preceding arguments are compelling enough for the researcher to also conjecture that ownership plays a role in determining some amount of tax avoidance at the corporate level. This study is motivated by the fact that even though several studies abound on the corporate tax avoidance phenomenon, only a handful are on developing countries. In addition, only few present evidence from Nigeria. Furthermore, of the studies which examine the issue for Nigeria, to the best of the researchers‟ knowledge only Ekoja and Jim-Suleiman (2014) examined the issue for banks. Their study however only provided evidence as to how an external governance mechanism; competition, plays a role in determining Nigerian banks‟ tax avoidance. Major failures in internal corporate governance mechanisms are thought to be one of the principal factors that have continually undermined bank performance (Sanusi, 2012).The Nigerian banking sector tends to be a key driver of activities in the corporate sector. This it achieves primarily through its principal role in financial intermediation. An OECD (2009) report also suggests that banks are particularly creative in structuring tax avoidance schemes both for themselves and their clients. These features of banks as well as differing arguments in the literature (e.g. Adams & Mehran, 2003; Becher & Frye, 2008) as to whether internal corporate governance mechanisms are actually effective in regulated entities such as banks, serve as motivation for this study to examine to what extent corporate governance mechanisms-specifically internal ones- determine tax avoidance for DMBs in Nigeria. 1.2 Statement of the Problem Tax avoidance has, especially in the last decade or so, come under increased scrutiny and criticism by governments, the media, aid groups as well as the general public. The reason for this is because even though tax avoidance in itself is not an illegality, as the law has not made it so, the amounts of revenue thought to have been lost through various ingenious avoidance activities world-wide have become an issue of concern. For instance, the Task Force for Financial Integrity and Economic Development, a global coalition of non-profit groups that campaign for transparency in the financial system, put the global foreign aid budget at $1 billion per year while it estimated that the developing world loses $1 trillion every year through evasion and/ avoidance, corruption as well as money laundering (Reuters, 2013). The Global Financial Integrity (GFI), another advocacy group, in its 2012 report, estimated that $5.86 trillion moved from developing countries to tax havens over the period from 2001 to 2010 with outflows from Nigeria alone amounting to a princely $129 billion. This princely sum earned the nation seventh spot on the GFI‟s top ten list of developing countries with the highest illicit outflows. A further breakdown of the components of the illicit outflows shows that the greatest part (i.e. 60% – 65%) was as a result of tax avoidance(Philippines Star, 2013).Arising, in part, from concerns over the aforementioned lost amounts of revenue; researchers have also upped the ante on the analysis of tax avoidance. While however still acknowledging the legality of tax avoidance, several researchers such as Potas (1993), Christensen and Murphy (2004), Fuest and Riedl (2009), Sikka (2010), Prebble and Prebble (2013) and Fischer (2014), amongst others, bring to the fore the argument that the legality of a phenomenon does not necessarily translate to that phenomenon being fair or ethically and morally acceptable. This argument is particularly evident regarding the phenomenon of tax avoidance. This is because tax avoidance contributes to a situation whereby tax payers of the same income bracket will not pay taxes on the same marginal tax rate. This has the effect of making the tax system appear unfair to those who are unable to avoid taxes.Research on corporate tax avoidance in comparison with that of tax avoidance by individuals could however be said to be of relatively recent focus. The said recent focus of research on the phenomenon has also tended to be conducted principally in developed climes. The earlier empirical studies on corporate tax avoidance such as Gupta and Newberry (1997) had focused more on the interplay between firm-specific characteristics such as size, leverage, profitability, capital intensity, amongst others in determining corporate tax avoidance. Given that the results on the association between the studied firm-specific characteristics and tax avoidance turned out to be far from consistent (e.g., Richardson&Lanis, 2007 and Hsieh, 2012); researchers further broadened the scope of investigation, on the determinants of corporate tax avoidance, to include other factors such as corporate transparency (Wang, 2010), CEO/manager effects (Dyreng, Hanlon &Maydew, 2010; Chyz, 2010), ownership structure (Badertscher, Katz &Rego, 2009; Chen, Chen, Cheng &Shevlin, 2010), external auditor effects (Mcguire, Omer & Wang,2010; Huseynov&Klamm, 2012), incentives (Philips, 2003; Armstrong, Blouin&Larcker, 2012) and a host of other characteristics. The basis for broadening of the scope of investigation has however been questionedby Hanlon &Heitzman (2010). They contend that the choice, by researchers,of what variables to study as determinants of corporate tax avoidance has seldom been backed by theory. Thus, in order to provide a theoretical base for the study of corporate tax avoidance, a relatively young but burgeoning literature which seeks to situate the determinants of corporate tax avoidance within an agency theoretical framework has emerged. According to Hanlon and Heitzman (2010), theoretical arguments for the study of corporate tax evasion and avoidance as agency issues have been pioneered by Crocker and Slemrod (2004), Slemrod (2004), as well as Chen and Chu (2005). The pioneers however failed to back their arguments with empirical data. Thus other researchers have sought empirical evidence in support of the framework. Specifically Desai and Dharmapala (2007), Minnick and Noga (2010), Khaoula and Ali (2012), Zemzem and Ftouhi (2013), Khaoula (2013) and Armstrong, Blouin, Jagolinzer and Larcker (2015) are amongst a spate of relatively recent researches that have directly examined the interplay between corporate governance mechanisms and tax avoidance.A common theme across the aforementioned studies that directly relate governance mechanisms with corporate tax avoidance is that while they refer to governance broadly, they habitually study only board related mechanisms to the detriment of other governance mechanisms. Governance is a myriad of mechanisms which are both external to the corporation as well as internal to it. For instance, shareholder and stakeholder monitoring, competition, the markets for both managerial and corporate control as well as debt covenants are all governance mechanisms. Therefore narrowing such a multi-faceted concept down to only board mechanisms does not appropriately proxy the phenomenon. The said empirical studies have also not been consistent in documenting either significant associations or similar signs of association in their studies. One possible reason for the inconsistencies may be because none of the past studies has considered whether interactions with other variables are the actual force behind the effects of the studied mechanisms on tax avoidance. As Hermalin and Weisbach (2003) and Adams, Hermalin and Weisbach (2010) point out, the effect of board mechanisms on firm performancemay not be direct. Therefore failure to take this into consideration is likely to distort interpretations. In this study, it is therefore proposed that concentrated ownership moderates the relationship between board structure proxies such as size and independence on corporate tax avoidance. Considering this moderating effect is important because shareholders with concentrated ownership (blocks and institutions) usually leverage upon their concentrated holdings to either directly sit on the board of directors or indirectly have a representative as director (La Porta, Lopez-de-Silanes, Schleifer&Vishny, 1998). This representation on the board is likely to affect both board advisory capacity (size) as well as monitoring capacity (independence). Furthermore, Connelly, Hoskisson, Tihanyi and Certo (2010) have argued that concentrated ownership leads to concentrated decision rightsand this leads to superior monitoring.Localizing the focus to Nigeria, the researcher observes that the discourse as well as study of corporate tax avoidance is yet to gather full momentum. Most existing studies such as AbdulRazaq (1985), Alabede, Ariffin and Idris (2011) and Ibadin and Eiya (2013), to name a few, focused on examining individual tax compliance issues. This is despite assertions by researchers such as Adegbie and Fakile (2011a, 2011b), that in Nigeria, the contribution to overall tax revenue by companies has continually fallen far short of expectations. This lack of research momentum may however be, in part, because evidence on whether Nigerian corporations actively engage in tax avoidance schemes, is largely anecdotal; evasion headlines seem to feature more prominently (see for example news on Proshare website accessed by the researcher on 15/03/2013, about tax evasion by petroleum companies as well as a This Day online news report accessed on the same date on the issue of evasion in the automobile industry in Nigerian). The anecdotal nature of narrations on the extent of corporate tax avoidance in Nigeria is however not surprising. This is because the very nature of tax avoidance demands some degree of obfuscation (Desai &Dharmapala, 2006; 2007; 2009a). Thus as a research issue corporate tax avoidance is only very recently receiving academic interest in Nigeria with studies such as James and Igbeng (2014) and Ekoja and Jim-Suleiman (2014). The James and Igbeng (2014) study however merely gave a theoretical exposition of the matter which is to a large extent a re-echo of Desai and Dharmapala (2007). Ekoja and Jim-Suleiman (2014) on the other hand studied the effect of competition on tax avoidance by Nigerian deposit money banks (DMBs) and reported the surprising result that competition alone explains 100% of the variation in Nigerian DMBs tax avoidance; a situation that is hardly plausible for social science phenomena. Their results are therefore suggestive of either measurement issues that have to do with the proxies used by the study or data inaccuracies.The focus of this research was therefore on furthering study on the agency theory perspective of tax avoidance. In order to achieve this the association between corporate governance mechanisms and tax avoidance in Nigerian DMBs was examined. The research focused on banks because differing regulation meant their exclusion from analysis by several past international studies on corporate tax avoidance (e.g., Zimmerman, 1983; Taylor &Richardson, 2011; Abdul Wahab, 2011) while in Nigeria, to the best of the researchers‟ knowledge only Ekoja and Jim-Suleiman (2014) have previously studied tax avoidance by banks. It seems therefore that the financial sector has not been adequately covered by researchers in relation to tax avoidance. Studying the sector is important because Minnick and Noga (2010), have earlier posited that different companies with different governance structures are likely to choose different tax management strategies. Given this assertion, it may therefore be misleading to assume that the empirical results of studies of some corporate sectors will hold for other sectors. Providing sector-specific contexts to show the interplay between governance and tax avoidance is therefore necessary. Consequently, the study sought to fill the gap on the determinants of corporate tax avoidance in DMBs in Nigeria. In particular, this was done by examining the extent to which internal corporate governance mechanisms play a role in determining corporate tax avoidance in DMBs in Nigeria. To realize this board size, ownership and independence as well as high block ownership concentration were studied. The interactions between concentrated ownership and board size as well as board independence were also examined. In addition the study sought to fill the gap on available research from the developing world; more so, with specific reference to the literature gap on corporate tax avoidance in Nigeria. The study also covered the banking sector, a part of the financial services sector that has been relatively understudied in relation to the tax avoidance phenomenon.
1.3 Research Questions To facilitate inquiry the following research questions were raised:
i. Does board size have a significant effect on corporate tax avoidance among DMBs in Nigeria?ii. Does board independence have a significant effect on corporate tax avoidance among DMBs in Nigeria?iii. Does high ownership concentration have a significant effect on corporate tax avoidance among DMBs in Nigeria?iv. Does board ownership have a significant effect on corporate tax avoidance among DMBs in Nigeria?v. Does high ownership concentration significantly moderate the relationship between board size and tax avoidance among DMBs in Nigeria?vi. Does high ownership concentration significantly moderate the relationship between board independence and tax avoidance among DMBs in Nigeria?1.4 Objectives of the Study The overall objective of this study is to determine to what extent internal corporate governance mechanisms determine tax avoidance in Nigerian deposit money banks. The specific objectives of the study are to:i. assess whether board size has a significant effect on corporate tax avoidance among DMBs in Nigeria.ii. ascertain whether board independence has a significant effect on corporate tax avoidance among DMBs in Nigeria.iii. estimate whether high ownership concentration has a significant effect on corporate tax avoidance among DMBs in Nigeria.iv. evaluate whether board ownership has a significant effect on corporate tax avoidance among DMBs in Nigeria.v. examine whether high ownership concentration moderates the relationship between board size and tax avoidance among DMBs in Nigeria.vi. examine whether high ownership concentration moderates the relationship between board independence and tax avoidance among DMBs in Nigeria.1.5 Statement of Hypotheses In line with the aforementioned objectives of the study, the following hypotheses; stated in null form,were formulated for testing: Ho1: board size has no significant effect on corporate tax avoidance among DMBs in Nigeria. Ho2: board independence has no significant effect on corporate tax avoidance among DMBs in Nigeria. Ho3: high ownership concentration has no significant effect on corporate tax avoidance among DMBs in Nigeria. Ho4: board ownership has no significant effect on corporate tax avoidance among DMBs in Nigeria. H05: the relationship between board size and tax avoidance among DMBs in Nigeria is not significantly moderated by high ownership concentration. H06: the relationship between board independence and tax avoidance among DMBs in Nigeria is not significantly moderated by high ownership concentration.
1.6 Scope of the Study This study empirically examined the effect of internal corporate governance mechanisms on corporate tax avoidance in Nigeria. The study covered only listed Deposit Money Banks (DMBs) in Nigeria. The focus on banks was in part, hinged on the role of banks as financial intermediaries in the economy. This role therefore means that banks tend to drive activities in the corporate sector. There are also assertions that banks structure transactions both for customers and themselves that are likely to facilitate tax avoidance (OECD, 2009). The study covered the period 2006 to 2014. The year 2006 was chosen as a base year so as not to allow the effects of the 2005 banking sector consolidation exercise to distort results while 2014 represents the latest year beforethe CBN classification of some DMBs as strategically important (CBN 2014a). The new classification, effective March 1, 2015 imposes stringent requirements on the said banks in respect of liquidity and capital adequacy requirements. The requirements are likely to affect some financial statement items and therefore introduce some distortion in analysis. The period overlaps with the 2001-2010 previously noted by the GFI (2012) report as the period in which Nigeria lost substantial revenue through avoidance activities. 1.7 Significance of the Study The study is significant for the following reasons:Firstly, taxes are a key source of revenue for governments and often feature prominently in government‟s income redistribution function. Government, through its relevant tax agencies, is therefore interested in identifying which characteristics matter most in determining cross-sectional differences in tax avoidance for corporate bodies such as the banks that were studied. The findings of the study that revealed significant associations between internal corporate governance mechanisms and corporate tax avoidance in DMBs in Nigeria will therefore aid government in designing proper policy both in respect of corporate governance and in respect of tax avoidance. Secondly, researchers are interested in understanding determinants of corporate tax avoidance.The study serves to add to the overall existing literature on the determinants of corporate tax avoidance by filling the gaps on corporate tax avoidance research in the developing world as well as in relation to documenting results from one class of highly regulated entities- banks. Thirdly, in terms of theory, the research is significant for its contribution to the agency theoretical perspective in relation to corporate tax avoidance. In its barest form, the agency perspective does not consider interactions. The study has modified the framework to reflect the fact that highly concentrated ownership interacts together with specific board mechanisms to be effective in ensuring goal congruence. Fourthly, shareholders wish to know whether the management appointed by them is properly controlling the organizations expenses; in this case taxes, in the direction of increasing shareholder wealth. Since the study focused on the effect of corporate governance mechanisms on tax avoidance, the study will benefit shareholders by showing them which internal governance mechanisms they should pay more attention to in their desire to achieve more effective tax outcomes such as avoidance.