Executive Fiduciary Duty and Corporate Tax Avoidance:

Evidence from a Delaware Case Ruling

Qiang Cheng School of Accountancy, Singapore Management University

Mark (Shuai) Ma

Kogod School of Business, American University

Wenjia Yan School of Business, University of Hong Kong

Yijiang Zhao

Kogod School of Business, American University

March 2017

Very preliminary; please do not quote or cite.

Abstract

A 2009 Delaware court ruling extended fiduciary duties from corporate directors to non-director executives, including chief financial officers (CFOs). Exploiting this natural experiment, we find that the affected firms – Delaware firms with CFOs not serving on the board – experience a significant increase in the level of tax avoidance in the post-ruling period, compared to other firms. Furthermore, the effect is more pronounced for the affected firms that have weaker governance, a lower level of tax avoidance prior to the ruling, and more powerful CFOs. We find that the affected firms also experience a decrease in tax risk after the ruling compared to other firms. Overall, this study is the first to document systemic evidence that fiduciary duties encourage executives to avoid more taxes and reduce tax risk. JEL classification: H26; G34; K22 Key Words: Corporate Tax Avoidance; Executive Fiduciary Duties; Tax Risk; Delaware Rulings.

Cheng acknowledges funding from the Lee Kong Chian Chair Professorship at Singapore Management University. Please contact authors at qcheng@smu.edu.sg (Qiang Cheng), shuaim@american.edu (Mark Ma), yanwj@hku.hk (Wenjia Yan), and yzhao@american.edu (Yijiang Zhao) for comments.

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1 Introduction

The government (federal, state and local) takes a greater than one-third share of a firm’s

taxable income. Given the significance of this tax cost to the firm and shareholders, cash savings

from tax avoidance is desired by shareholders. However, engaging in tax avoidance activities is

costly to executives who undertake such activities, including the effort, reputation loss, and the

potential penalty imposed by the IRS.1 These significant costs could discourage executives from

fully taking advantage of tax avoidance opportunities and maximizing shareholder value, leading

to an agency conflict between shareholders and executives in the case of tax avoidance. As such,

how to induce executives to undertake optimal tax avoidance activities is an important issue to

shareholders. Prior research has documented that firms use various incentive-based

compensation and governance mechanisms to induce executives to avoid taxes. In this paper, we

study another mechanism that can affect executives’ incentives in engaging in tax avoidance

activities – executives’ fiduciary duties.

More specifically, this study examines whether executives’ fiduciary duties affect

corporate tax avoidance behavior. Analyzing tax avoidance within an agency framework, a

stream of studies examines the effect of firm-level governance mechanisms such as executive

compensation and ownership structure on corporate tax avoidance (e.g., Rego and Wilson 2012;

Chen, Chen, Cheng, and Shevlin 2010; McGuire, Wang, and Wilson 2014; Bird and Karolyi

2016). Meanwhile, prior law and finance studies (e.g., Hart 1993; Donelson and Yust 2014; Laux

2010) suggest that shareholder litigation against executives for breaches of fiduciary duties is a

critical mechanism to address agency problems. Very little empirical work, however, has

investigated whether and how executives’ fiduciary duties (and the resulted shareholder litigation

1 For example, Tyco was charged for intentionally failing to report more than $170 million in income on its 1999 corporate tax return. As a result, the former head of Tyco International Ltd.’s tax department, Raymond Stevenson, was sentenced to three years in prison after pleading guilty.

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risk faced by executives), an important personal legal mechanism, affect corporate tax

avoidance. Our study aims to fill this gap in the literature.

Our study is also motivated by the recent debate on whether the fiduciary duty of

executives and outside directors contributes to tax avoidance.2 Breaches of fiduciary duties could

lead to shareholder lawsuits against directors and executives. As corporate tax avoidance has

grown rapidly in recent years, companies and their consultants often attribute aggressive tax

planning to executives’ fiduciary duties to maximize after-tax profit (e.g., Underhill 2013; Lilico

2013). However, advocacy groups that are concerned about corporate tax avoidance argue that

fiduciary duties do not encompass tax avoidance and are merely used as an excuse for tax

avoidance (e.g., Tax Justice Network 2013). At the core of this debate is whether executives’

fiduciary duties actually contribute to aggressive tax avoidance. Our study contributes to this

debate by directly testing the effect of fiduciary duties on tax avoidance.

It is unclear a priori whether and how executive fiduciary duties affect corporate tax

avoidance. On one hand, an executive who might be sued by shareholders for breaches of

fiduciary duties could face severe penalties, such as fines, being barred from serving as an

executive or director, and a loss of reputation (e.g., Laux 2010).3 Such ex post penalties motivate

executives to make corporate decisions from the shareholders’ perspective, thus mitigating

managerial agency problems (e.g., Hart 1993; Dharmapala and Khanna 2013; Donelson and Yust

2014). To the extent that shareholders believe that corporate tax avoidance is part of executives’

2 When discussing fiduciary duties, commentaries (Underhill 2013; Lilico 2013) usually do not distinguish between inside and outside directors. Similarly, prior research (e.g., Hart 1993) uses a generic term “management” without differentiating between executives and outside directors when discussing fiduciary duties. Because corporate tax avoidance is generally subject to executives’ decisions and because the 1999 Delaware setting involves changes in executive fiduciary duties, our study’s discussion is geared toward executives. However, to the extent that outside directors are also involved in corporate tax planning activities, our inference also applies to outside directors. 3 As Laux (2010) notes, although directors’ and executives’ insurance helps to shield them from direct financial loss, being a defendant in a lawsuit brings about other significant costs, such as loss of reputation, loss of time, and an emotional burden.

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fiduciary duties to maximize shareholder value, the threat of shareholder law suit motivates

executives to avoid more taxes.4 This argument implies that fiduciary duties have a positive

effect on tax avoidance. On the other hand, fiduciary duties may not encourage tax avoidance for

a few reasons. One may argue that executives’ fiduciary duties do not encompass tax avoidance

(Tax Justice Network 2013), or that shareholders do not believe that they do. In addition, the

governance mechanism may have encouraged executives to undertake effective tax planning to

avoid taxes, which marginalizes the role of executive fiduciary duties in tax avoidance. Given

these competing arguments, the effect of executive fiduciary duties on tax avoidance is an

empirical question.

A major empirical challenge in studying the effect of executive fiduciary duties on tax

avoidance is to capture the variation in executives’ fiduciary duties. Without such a variation

over time or across firms, one cannot empirically demonstrate its effect. We overcome this

challenge by exploiting an exogenous shock that increased the fiduciary duties of non-director

executives in Delaware firms in 2009. Specifically, in the case of Gantler v. Stephens (hereafter,

Gantler) in 2009, the Delaware Supreme Court ruled for the first time that corporate executives

owe the same fiduciary duties of care and loyalty to the corporation and its shareholders as

corporate directors.5 For Delaware firms prior to the ruling, fiduciary duties apply only to

corporate directors, including the executives who are serving on the board. After the ruling the

executives who do not serve on the board in Delaware firms have the same fiduciary duties as

those who serve on the board (Follett 2010). The ruling provides us a unique setting to examine

the causal effect of executives’ fiduciary duties on corporate tax avoidance.

4 For example, in a recent Delaware law case, Seinfeld v. Slager (2012), a shareholder of Republic Services, Inc. sued corporate officers and directors for breaches of fiduciary duties. The shareholder alleged that the “defendants failed to minimize taxes (p. 9)” because the corporation approved a retirement bonus plan that did not qualify for a tax deduction. 5 Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. 2009).

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Empirically we focus on the increase in fiduciary duties of CFOs rather than that of other

executives in this setting for two reasons. First, the CFO is a company’s top executive who is

directly responsible for corporate income taxes and other financial issues (e.g., Crocker and

Slemrod 2005; Mian 2001). Prior empirical studies (e.g., Dyreng, Hanlon, and Maydew 2010;

Francis, Hasan, Wu, and Yan 2014) also suggest that CFOs’ personal traits are associated

corporate tax avoidance decisions. Second, focusing on CFOs could increase the statistical power

of our analyses. While CEOs might also be involved in tax planning, they usually serve as

directors and thus are not affected by the Gantler ruling. In contrast, far fewer CFOs serve on the

board of directors (Bedard, Hoitash, and Hoitash 2014). Thus, the Gantler ruling effectively

increased fiduciary duties for non-director CFOs of Delaware firms, and focusing on CFOs

enables us to better detect the potential effects of executive fiduciary duties on tax avoidance.

Two characteristics of the Gantler ruling shape our research design. First, this ruling

applies only to firms incorporated in Delaware and does not affect firms incorporated in other

states. Second, it affects only Delaware firms whose CFOs do not serve on the board of directors

(the treatment firms) and does not affect those where the CFOs serve on their companies’ boards.

Therefore, we examine whether and how the Gantler ruling affects tax avoidance behavior of the

Delaware firms with CFOs not on the board, while using all other firms as control firms. We

follow prior studies on other Delaware court rulings (e.g., Low 2009; Aier, Chen, and Pevzner

2014) and use a difference-in-difference-in-difference approach to examine our research

question.

Our empirical tests are based on a sample of U.S. firms during 2005-2012, an eight-year

period surrounding the 2009 Delaware ruling. Following prior studies (e.g., Dyreng, Hanlon, and

Maydew 2008), we define tax avoidance broadly to encompass any behavior that reduces a

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firm’s tax payments. As such, our main proxy for tax avoidance is the cash effective tax rate

(hereafter, Cash ETR). Cash savings is the primary benefit of tax avoidance to shareholders.

Cash ETR measures the overall reduction in cash tax paid relative to its pretax income in the

current period; a lower value of Cash ETR implies more tax avoidance. We find that after the

Gantler ruling, Delaware firms with CFOs not serving on the board experience a significant

decrease in Cash ETR, compared to control firms. The effect is also economically significant; the

decrease is about 24% of the sample mean of Cash ETR. The findings are robust to controlling

for other determinants of tax avoidance as well as firm fixed effects. This evidence suggests that

an increase in executive fiduciary duties leads to more corporate tax avoidance.

We conduct several tests to investigate the conditions under which the effect of CFO

fiduciary duties on tax avoidance is stronger or weaker. First, we examine whether corporate

governance mechanisms substitute the effect of CFO fiduciary duties. To the extent that CFOs’

fiduciary duties align CFOs’ interest with that of shareholders, we expect the effect of CFOs’

fiduciary duties to be more pronounced in firms with weak corporate governance. Consistent

with this prediction, we find that the results are more pronounced for firms with more

antitakeover provisions, firms facing weaker product market competition, and firms with less

independent boards. Second, we investigate whether the effect of CFO fiduciary duties is more

pronounced for firms with lower tax avoidance prior to the Gantler ruling. For firms that were

less effective in tax planning before the ruling, shareholders are more likely to sue executives,

including CFOs, for failing to minimize taxes after the ruling if they continue to be ineffective.

Thus, we expect the effect of CFO fiduciary duties to be stronger in firms with lower tax

avoidance in the pre-ruling period. Our results are consistent with this expectation. Third, if the

ruling affects CFOs’ incentive to reduce taxes, we expect this effect to be more pronounced in

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firms with more powerful CFOs, because these CFOs likely have a bigger impact in tax planning

and are more likely to take action in response to the increased litigation risk from fiduciary

duties. Using CFOs’ compensation relative to that of other top executives to capture CFO power,

as done in Cheng et al. (2016), we document results consistent with this conjecture.

We also conduct several additional tests to provide additional insights and to investigate

the robustness of the results. First, we find that the Delaware firms with CFOs not serving on the

board also experience a decrease in tax risk (proxied for by unrecognized tax benefits and

standard deviation of Cash ETR) after the Gantler ruling, consistent with CFO fiduciary duties

also improving tax compliance and tax risk management. Second, we conduct two falsification

tests and the results support our argument that the documented effect is driven by the change in

CFO’s fiduciary duties, not by other potential confounding effects or differential time trends for

treatment and control firms. Lastly, our results are robust to alternative sample selection

procedures, alternative measures of tax avoidance, and other alternative model specifications.

Our study contributes to the literature in several important ways. First, we contribute to the

literature on the determinants of corporate tax avoidance. In particular, prior studies (e.g., Rego

and Wilson 2012; Armstrong, Blouin, and Larcker 2012; Chen, Chen, Cheng, and Shevlin 2010;

Cheng, Huang, Li, and Stanfield 2012) suggest that incentive-based compensation and

governance mechanisms play an important role in motivating or inducing management to be

more effective in tax planning. Unlike these studies, our study focuses on executive fiduciary

duties and the corresponding litigation risk, a legal mechanism that helps address agency

problems in the context of tax avoidance. Our findings suggest that this legal mechanism induces

executives to be more effective in tax planning. Our study also complements Dyreng et al.

(2010) who find that individual executives have a significant impact on tax avoidance.

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Exploiting a natural experiment that changes CFOs’ fiduciary duties and personal legal risk, our

study suggests that fiduciary duties are one reason why individual executives affect corporate tax

avoidance.

Second, we contribute to the literature on the effect of executives’ fiduciary duties on

corporate behavior. Donelson and Yust (2014) find that executive and director fiduciary duties

increase firm value and reduce financial reporting errors. Levy, Shalev, and Zur (2014) find that

an increase in CFO fiduciary duties induces more timely disclosure of negative news and more

conservative financial reporting. We extend this line of literature by examining the effect of

executives’ fiduciary duties on corporate tax avoidance.

Lastly, our study contributes to the ongoing debate on whether executives’ fiduciary duties

contribute to corporate tax avoidance. As discussed above, corporations often argue that the

threat of shareholder lawsuits on breaches of fiduciary duties leads firms to be more aggressive

in avoiding taxes, yet advocacy groups such as TJN challenge such argument. Our findings are

consistent with the former’s point that executives’ fiduciary duties and personal litigation risk

contribute to tax avoidance.

The remainder of the paper proceeds as follows. In the next section, we discuss the related

studies on fiduciary duties and corporate tax avoidance, and then develop our hypothesis. Section

3 describes the research design, data, and sample selection procedure. Section 4 presents main

empirical results and additional analyses. Section 5 concludes.

2 Literature Review and Hypothesis Development

2.1 Corporate law, fiduciary duty, and tax avoidance

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2.1.1 Fiduciary duty under corporate law

US corporations are subject to the corporate law of their state of incorporation. A state’s

corporate law includes not only statutes, but also case rulings. Corporate laws vary across states.

Compared to other states, Delaware is appealing to many firms for its specialized legal capital,

significant legal precedents, and responsiveness in updating legislation (e.g., Romano 1987). As

Delaware attracts more and more firms to incorporate, the case law of Delaware has become

increasingly influential.

According to state corporate laws, the fiduciary duty is generally subdivided into the duty

of care and the duty of loyalty. The duty of care requires management to make corporate

decisions after taking all available information into account, and then act in a judicious manner

that promotes the company's best interests. The duty of loyalty stands for the principle that

management must act without conflicting interest in making corporate decisions. Managers who

owe fiduciary duty to shareholders can be sued in state courts if they fail, or are perceived to fail,

to fulfill their fiduciary duties (e.g., Hart 1993).

2.1.2 Executives’ fiduciary duties: Gantler v. Stephens

In this paper, we use a natural experiment setting, a Delaware court ruling (Gantler v.

Stephens, hereafter, Gantler) in 2009 that corporate executives not serving on the board owe the

same fiduciary duties of care and loyalty to the corporation and its shareholders as do corporate

directors, to examine the impact of executive fiduciary duties on tax avoidance. Prior to the

Gantler ruling, no legal action was brought against executives who are not serving on the board.

In this lawsuit, a shareholder of First Niles sued the five directors and one non-director executive

for breaching fiduciary duties in an M&A transaction. The directors and the executive were sued

for not providing appropriate information for potential buyers of the bank. For the first time in

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Delaware’s business history, the Delaware Supreme Court ruled that both the five directors and

the non-director executive owe the same fiduciary duties to the shareholders. As a result, the

Gantler ruling extended the fiduciary duties from directors only, including executives serving on

the board, to all directors and executives of Delaware firms. After the ruling, shareholders can

sue corporate executives for breaching fiduciary duties (Follett 2010). This ruling represents an

exogenous shock to the fiduciary duties of the executives of Delaware firms who do not serve on

the board of directors.6

2.1.3 Does fiduciary duty encompass tax avoidance?

Although corporate laws do not clearly state whether executives’ fiduciary duties

encompass tax avoidance, recent anecdotes and debates indicate that at least some believe that

they do. For example, CNBC’s host Jim Cramer, whose trust owned Apple Inc.'s stock, argued

that Apple’s CEO has a fiduciary duty to avoid corporate taxes for shareholders.7 William

Underhill, a partner of a consulting firm for corporate clients, also argued that directors’

fiduciary duties will drive decisions to lower corporate taxes, because tax avoidance benefits

shareholders financially (Underhill 2013).8 Similar opinions can be found in Lilico (2013) and

Avi-Yonah (2014).

There are also lawsuits showing that shareholders sued corporate executives for not

avoiding corporate taxes. For example, in a recent Delaware law case, Seinfeld v. Slager (2012),

a stockholder of Republic Services, Inc. sued the top executives and directors for breach of

fiduciary duties to minimize taxes. One claim that the plaintiff presented is that an incentive

6 While based on the code law of many states, only directors owe the fiduciary duties, in some states such as Pennsylvania and Nevada, both directors and non-director executives owe fiduciary duties to corporations and their shareholders. However, we are not aware of any change in fiduciary duties in other states in recent years. 7 Defending Apple CEO Tim Cook’s tax avoidance strategies, CNBC’s host Jim Cramer argued recently that every manager has a fiduciary duty to minimize the company’s corporate tax liabilities (http://www.cnbc.com/2015/12/21/cramer-apples-tim-cook-patriotic-on-taxes.html). 8 Underhill (2013) argues that if the board of a company has no information on the tax implications of issuing either equity or debt to finance an investment activity, it would be likely to have failed its duty of care.

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payment to Republic Services’ executives was not tax-deductible and that it also rendered the

company’s compensation plan not tax efficient. In this law case, the judge of the Delaware

Chancery Court acknowledged that “under certain circumstances overpayment of taxes might be

the result of a breach of fiduciary duty.” Another Delaware law case, Freedman v. Adams

(2012), concerns an executive compensation plan approved by the board of XTO Energy, Inc.

The plaintiff argued that the XTO board, “had a duty to adopt a § 162(m) plan” so that payments

to top executives in excess of $1 million would be tax-deductible.9 Although the Delaware

Chancery Court disagreed, judges also stated that, “This is not to say that under certain

circumstances overpayment of taxes or a poor tax strategy might not result from breaches of the

fiduciary duties of care or loyalty or constitute waste (Freedman, 2012 WL 1099893).”10

2.2 Prior literature on determinants of corporate tax avoidance

Our study relates to the literature on how incentive and governance mechanisms affect the

level of corporate tax avoidance. Aggressive tax planning is widely viewed as a type of risky

investment activities (e.g., Rego and Wilson, 2012). Thus, risk-averse executives tend to select a

lower level of tax avoidance than what shareholders prefer. To address this issue, firms adopt

various incentive-based compensation and governance mechanisms to induce executives to be

more aggressive in tax planning. Consistent with this notion, several studies find that executives’

incentive-based compensation, including CEOs and CFOs’ equity incentives (e.g., Rego and

Wilson 2012), tax directors’ incentive compensation (Armstrong, Blouin, and Larcker 2012), and

the use of after-tax accounting earnings in CEO bonus compensation (e.g., Gaertner 2014), are

associated with higher tax avoidance. Analyzing various governance mechanisms, recent studies

9 Section 162(m) of the Internal Revenue Code allows a tax deduction for payments to a CEO or other top executives made pursuant to a shareholder-approved plan and tied to “the attainment of one or more performance goals” (thus usually referred to as a “§ 162(m) plan”). 10 It should be noted that both case rulings are decisions of the Delaware Chancery Court, which is subordinate to the Delaware Supreme Court.

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further find that hedge fund activism (e.g., Cheng, Huang, Li, and Stanfield 2012), takeover

market monitoring (e.g., McGuire, Wang, and Wilson 2014), and institutional investor

monitoring (e.g., Bird and Karolyi 2016; Khan, Srinivasan, and Tan 2016) increase corporate tax

avoidance.

These prior studies generally focus on firm-level incentive-based compensation and

governance mechanisms. Economists (e.g., Hart 1993) note the important role of shareholder

litigation against breach of fiduciary duties in aligning executives’ interest with that of

shareholders. Yet, to the best of our knowledge, there is no evidence on how executives’

fiduciary duties and the resulted litigation risk, a legal mechanism at the executive level, affect

corporate tax avoidance. 11 Our study fills this gap.

Our study is also related to the nascent literature on the effects of managerial traits on

corporate tax avoidance. A seminal study by Dyreng, Hanlon, and Maydew (2010) finds that

individual executives have a significant effect on a company’s tax avoidance activities (i.e.,

executive fixed effects). Several follow-up studies further link executives’ attributes, such as

personal tax aggressiveness (Chyz 2013), personal traits such as narcissism (Olsen and

Stekelberg 2015), military experience (Law and Mills 2015), political orientation (Christensen,

Dhaliwal, Boivie, and Graffin 2015), and gender (Francis, Hasan, Wu, and Yan 2014) to tax

avoidance. Their findings generally suggest that individual executives affect corporate tax

avoidance. Our study extends this line of research by examining executives’ fiduciary duties and

the resulted personal litigation risk on tax avoidance. In addition, because executives might self-

11 Our study examines the effect of the variation in executives’ personal litigation risk resulting from their fiduciary duties on tax avoidance and is thus different from studies on how tax authority monitoring and tax codes affect tax avoidance. For example, Hoopes et al. (2012) find a negative association between the probability of Internal Revenue Service (IRS) audit and corporate tax avoidance. Using a cross-country setting, Atwood et al. (2012) find that firms undertake less aggressive tax avoidance activities in the presence of stronger perceived tax enforcement. Note that executives’ personal litigation risk discussed in this paper results from their fiduciary duties, not from engaging in potentially illegal tax avoidance activities.

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select to work in firms with more- or less-aggressive tax avoidance, the direction of causality

generally remains unclear in these prior studies. Using a natural experiment of an exogenous

increase in non-director executives’ fiduciary duties and thus their personal litigation risk, our

study can better identify the causal effect of individual executives on corporate tax avoidance.

2.3 Hypothesis development

2.3.1 Main hypothesis

Prior literature suggests that shareholder lawsuits against breaches of fiduciary duties

provide a governance mechanism to reduce agency costs (e.g., Hart 1993). When executives owe

fiduciary duties to shareholders, shareholders can sue the executives for failing to carry out

particular transactions in the best interest of shareholders. Such litigation could lead to severe

legal penalties for corporate executives, such as fines and being barred from serving as

executives or directors, as well as reputation loss (e.g., Laux 2010). The threat of such litigation

risk increases executives’ incentive to maximize shareholder value. Consistent with this notion,

Donelson and Yust (2014) find that after Nevada significantly reduced the personal legal liability

of corporate management, Nevada firms experienced a decrease in firm value, operating

performance, and executives’ pay-for-performance sensitivity.

In the same vein, shareholder litigation risk from breaches of fiduciary duties is likely to

encourage executives to undertake more tax avoidance activities provided that (1) they have

fiduciary duties to shareholders and (2) fiduciary duties encompass tax avoidance. Corporate tax

avoidance is beneficial to shareholders by reducing corporate cash payments to the government.

However, ecutives (e.g., CEOs and CFOs) who are in charge of tax avoidance bear the cost of

such behavior (e.g., loss of reputation and legal penalties from carrying out potentially illegal tax

avoidance activities). For example, in February 2016, Caterpillar’s board of directors was sued

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for dodging $2.4 billion in taxes. Thus, corporate executives tend to underinvest in such risky

activities. As the aforementioned anecdotes show, many shareholders believe that executive

fiduciary duties encompass the duty to minimize corporate taxes. The law cases such as

Freedman v. Adams (2012) and Seinfeld v. Slager (2012) illustrate that corporate executives can

be sued by shareholders for not engaging in tax avoidance activities.12 Thus, enhanced fiduciary

duties expose executives to a higher level of shareholder litigation risk and, in turn, induce them

to undertake more tax avoidance activities.

Although tax avoidance benefits the shareholders by reducing cash payments, it has non-

tax costs such as a loss of reputation (e.g., Hanlon and Slemrod 2009; Graham et al. 2014), legal

penalties imposed by the Internal Revenue Service (e.g., Hoopes et al. 2012), and higher cost of

capital (e.g., Hasan et al. 2014). Assuming that the non-tax cost of tax avoidance does not change

when executives’ fiduciary duties increase, we would expect that the greater incentives of

conducting tax avoidance activities induced by the enhanced fiduciary duties lead to a higher

level of tax avoidance.

The above discussion leads to our first hypothesis (in alternative form):

H1: Executives’ enhanced fiduciary duty is positively associated with more corporate tax avoidance.

However, there are a few reasons why we might not observe results consistent with H1 and

H1a. First, one may argue that executive fiduciary duties do not encompass tax avoidance (e.g.,

Tax Justice Network 2013). If so, shareholder litigation risk faced by executives for failing to

avoid corporate taxes is low and thus is unlikely to affect tax avoidance activities. Second, the

firm-level governance mechanisms might have already encouraged executives to undertake tax

avoidance to the level preferred by shareholders (e.g., Cheng, Huang, Li, and Stanfield 2012;

12 Furthermore, because the definition of fiduciary duties is generally unclear, executives might believe that their fiduciary duties include tax avoidance. If so, the perceived litigation risk can lead to more-aggressive tax avoidance.

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McGuire, Wang, and Wilson 2014; Bird and Karolyi 2016). If this is the case, the increase in

executives’ fiduciary duties will not have an effect on tax avoidance. Lastly, even when

executives do not have fiduciary duties in the pre-ruling period, they have to report to the board

of directors, who have fiduciary duties to increase shareholder value. To the extent that reducing

taxes increases shareholder value and the board can perfectly monitor executives in tax

avoidance, the change in executives’ fiduciary duties does not affect the level of tax avoidance.

2.3.2 Manifestation of H1 in the Gantler ruling setting

As discussed above, we exploit the Gantler ruling to capture the change in executives’

fiduciary duties and to examine how executive fiduciary duties affect tax avoidance. After the

Gantler ruling, non-director top executives in Delaware firms have the same fiduciary duties as

directors. In contrast, there is no change in fiduciary duties for executives in non-Delaware firms

or for the executives in Delaware firms who serve on the board of directors. Thus, the increase in

fiduciary duties for non-director top executives in Delaware firms will induce them to be more

effective in tax planning, resulting an increase in an increase in the level of tax avoidance in

these firms.

Following Levy, Shalev, and Zur (2015), we do not consider all executives and focus on

CFOs instead for two reasons. First, a CFO is a firm’s highest executive directly responsible for

financial issues. Prior studies (e.g., Dyreng, Hanlon, and Maydew 2008; Francis, Hasan, Wu, and

Yan 2014) suggest that individual CFOs have significant impact on corporate tax avoidance.

Other non-CEO top executives are not directly involved in tax planning. Second, analyses of

CFOs potentially increase the power of the test. Unlike CEOs, who usually serve on their

companies’ board of directors,13 far fewer CFOs serve on the board (e.g., Bedard, Hoitash, and

Hoitash 2014). Thus, the Gantler ruling effectively increased the fiduciary duties for a 13 More than 90% of the firms in the RiskMetrics database have their CEOs on the board.

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significant proportion of Delaware company CFOs. Focusing on CFOs allows us to better detect

the effect of this ruling and executive fiduciary duties on tax avoidance. As such, H1 can be

better stated as following in the Gantler ruling setting:

H1a: Compared to other firms, Delaware firms with CFOs not serving on the board experience an increase in corporate tax avoidance from the pre- to the post-Gantler ruling period.

2.3.3 Cross-sectional variation

We next examine the conditions under which the hypothesized effect of fiduciary duties is

stronger. First, prior governance studies suggest that various incentive-based compensation (e.g.,

Rego and Wilson 2012; Gaertner 2014) and monitoring mechanisms (e.g., McGuire et al. 2014;

Bird and Karolyi 2016) better align executives’ interest with that of shareholders, thus

encouraging corporate executives to undertake tax avoidance activities. As such, we expect that

for firms with strong corporate governance, the effect of fiduciary duties on tax avoidance is less

important. In contrast, in weak-governance firms, the effect of executives’ fiduciary duties is

likely to be more pronounced. Accordingly, we state our second hypothesis as follows:

H2: The positive effect of enhanced executive fiduciary duties on corporate tax avoidance is stronger in firms with weaker corporate governance.

Second, firms vary in the level of corporate tax avoidance in the period prior to the Gantler

ruling. For those firms that are already tax aggressive, shareholders are less likely to sue their

executives for not avoiding enough taxes and the marginal effect of enhanced executive fiduciary

duties is likely lower. Conversely, for less tax aggressive firms, there is enough room for

improvement and executives’ personal litigation risk for not avoiding taxes as a result of the

enhanced fiduciary duties is likely to be higher. Therefore, there is more room for improvement

and these executives are likely to avoid corporate taxes more aggressively in response to the

increase in fiduciary duties. Our third hypothesis is thus stated as follows:

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H3: The positive effect of enhanced executive fiduciary duties on corporate tax avoidance is stronger in firms with lower tax avoidance in the pre-ruling period.

The last factor that we consider is the power and influence of non-CEO executives. Non-

CEO Executives with more power have greater influence and discretion over the firm’s decision

making, including tax planning. Assuming that there is no contemporaneous change in the

CEO’s fiduciary duties, for firms where non-CEO executives have more power, we expect the

increase in their fiduciary duties are more likely to lead to greater tax avoidance. Accordingly,

our fourth hypothesis is stated as follows:

H4: The positive effect of enhanced executive fiduciary duties on corporate tax avoidance is stronger in firms with more powerful non-CEO executives.

3 Data, Research Design and Descriptive Statistics

3.1 Sample selection and descriptive statistics

Our initial sample includes all U.S. listed firms during the eight-year period surrounding

the Gantler ruling in January 2009, with 2005 – 2008 as the pre-event period and 2009 – 2012 as

the post-event period. Using a six-year sample period, including three years (2006-2008) as pre-

event period and three years (2009-2011) as the post-event period, leads to the same inferences.

We use financial data retrieved from Standard and Poor’s Compustat database to calculate

the tax avoidance measure and control variables. We obtain the Governance Index data and data

on firms’ historical incorporation from the RiskMetrics database, and the data on managerial

ownership from ExecuComp. We further exclude firms in financial and regulated industries (SIC

codes 6000–6999 and 4400–4999) because firms in these industries might have different tax

planning incentives and opportunities.

In order to address the potential confounding effects, we adopt the following criteria to

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further restrict our sample.14 First, because the Gantler ruling was issued in January 2009, we

delete observations with fiscal years ending between January 2009 and May 2009 to ensure that

firm years before and after the ruling are clean. Second, we require firms to have at least one

observation in both the pre- and post-ruling periods. Third, we drop the firms that have CFOs

serving on the board in some years but not in other years. That is, we only keep the firms that

have CFOs serving, or not serving, on the board throughout the sample period. Finally, we delete

those observations with CEOs not serving on the board, because such observations may

confound our analyses on CFOs.

The final sample consists of 5,320 firm-year observations. Table 1 summarizes the sample

selection procedure.

3.2 Primary Measure of corporate tax avoidance

As Hanlon and Heitzman (2010) note, tax avoidance encompasses a continuum of tax-

planning strategies that aim to reduce a firm’ explicit taxes relative to its pretax income. Cash

savings are the primary benefit of tax avoidance to shareholders. Therefore, in our main

analyses, we use the cash effective tax rate (Cash ETR) as the main measure of tax avoidance, as

in many prior studies (e.g., Hanlon and Heitzman 2010; Hope, Ma, and Thomas 2013; Donohoe

2015; Dyreng, Hanlon, and Maydew 2008). Cash ETR is calculated as the ratio of cash taxes

paid to pretax income adjusted for special items. Firms with negative pretax income adjusted for

special items are excluded from the analyses. As argued in Hanlon and Heitzman (2010), Cash

ETR captures non-conforming tax avoidance activities as well as tax deferral strategies. By

definition, Cash ETR is an inverse indicator of firms’ tax avoidance.

3.3 Empirical model

The Gantler ruling only affects Delaware firms with CFOs not serving on the board of 14 Using a sample without imposing these additional sample selection restrictions leads to the same inference.

18

directors. After the ruling, these CFOs have the same fiduciary duties as directors. Thus, we refer

to these firms as treatment firms. Because the CFOs who are also directors have the fiduciary

duties to shareholders prior to the ruling, the ruling does not affect these CFOs and thus the firms

with CFOs on the board. In addition, the ruling does not affect firms incorporated in states other

than Delaware (i.e., non-Delaware firms). These two groups of firms are control firms. We

compare the change in tax avoidance from pre- to the post-ruling periods between treatment and

control firms to capture the effect of fiduciary duties on tax avoidance.

In this paper, we use a difference-in-differences-in-differences (DiDiD) approach to test the

effect of the 2009 Delaware court ruling (Gantler v. Stephens) on corporate tax avoidance

activities. The DiDiD approach has been commonly used in prior studies of other Delaware

rulings (e.g., Low 2009; Aier, Chen, and Pevzner 2014) as well as other regulatory changes

(Altamuro and Beatty 2010; Petacchi 2015).15 Specifically, our study examines whether

Delaware firms with non-board-serving CFOs (i.e., the treatment firms) change their tax

avoidance level in response to the Gantler ruling compared to the control firms.16 We use the

following model to test the hypothesis H1a:

CashETRit = β0 + β1 Postt + β2 CFO_Not_On_Boardi × Postt + β3 Delawarei × Postt + β4CFO_Not_On_Boardi × Delawarei × Postt + ɣControl Variablesit + Firm Effecti + εit

(1)

In the above model, Postt is the indicator for the post-ruling period. Because the Delaware

Supreme Court issued the Gantler ruling on January 27, 2009, we set Postt as one for years 2009

and onward, and zero otherwise. CFO_Not_On_Boardit is an indicator variable that equals one

15 Low (2009) examines the effect of the Delaware court rulings in Unitrin v. American General (1995) and Moore Corp. Ltd. v. Wallace Computer Services (1995). These rulings, which solidify the ‘‘just say no’’ defense, apply mainly to Delaware firms with staggered boards. Aier, Chen, and Pevzner (2015) focus on the Delaware court ruling in Credit Lyonnais Bank v. Pathe Communications in 1991, which expanded the scope of directors’ fiduciary duties to creditors when a Delaware firm is in the “vicinity of insolvency.” Similar to these court rulings, the Gantler ruling only affects a subset of Delaware firms. 16 In a sensitivity test, we only include the Delaware firms and use the difference-in-differences design. The inferences remain the same.

19

for firms in which the CFO does not serve on the board of directors, and zero otherwise.

Delaware is an indicator variable for Delaware firms, set as one for firms incorporated in

Delaware and zero otherwise. Because of the inclusion of firm fixed effects, we do not include

time-invariant variables such as CFO_Not_on_Board, Delaware, and CFO_Not_on_Board ×

Delaware in Model (1).

Based on the definition of the various variables, the coefficient on Postt captures the

change in Cash ETR from the pre- to the post-ruling period for non-Delaware firms with CFOs

serving on the board. The coefficient on CFO_Not_On_Boardi × Postt captures the incremental

change in Cash ETR for non-Delaware firms with CFOs not serving on the board from the pre-

to the post-ruling period, compared to non-Delaware firms with CFOs serving on the board. The

coefficient on Delawarei × Postt captures the change in Cash ETR of Delaware firms with CFOs

serving on the board from the pre- to the post-ruling period, compared to non-Delaware firms

with CFOs serving on the board. More importantly, the coefficient on CFO_Not_On_Boardi ×

Delawarei × Postt captures the difference-in-difference-in-differences: with the first difference

being the difference in Cash ETR between the pre- to the post-ruling period, the second being the

difference between firms with CFOs serving on the board and those without, and the third being

the difference between Delaware and non-Delaware firms. This coefficient captures the effect of

the Gantler ruling on tax avoidance. Because higher values of Cash ETR indicate lower levels of

tax avoidance, a negative (positive) coefficient on CFO_Not_On_Boardi × Delawarei × Postt

implies that Delaware firms with CFOs not serving on the board experience a decrease (increase)

in tax rate, or an increase (decrease) in tax avoidance, after the Gantler ruling, compared to

control firms. H1 and H1a imply a negative coefficient on CFO_Not_On_Boardi × Delawarei ×

Postt.

20

Following prior studies (e.g., Chen, Chen, Cheng, and Shevlin 2010; Hope, Ma, and

Thomas 2013), we control for a wide range of firm attributes that likely affect a firm’s incentives

and opportunities to avoid corporate taxes. These factors, as detailed in Appendix A, include

firm size (Size), profitability (ROA), growth opportunities (M/B), financial leverage (Leverage),

cash holdings (Cash Holding), intangible assets (Intangible Assets), capital intensity (Capital

Intensity), research and development (R&D), net operating loss carryforwards and its change

(NOL and ΔNOL), income related to equity method (Equity Income), and income from foreign

operations (Foreign Income). We also control for governance features including managerial

ownership (Managerial Ownership%) and the strength of takeover protection (G-Index). We

further include firm fixed effects to control for the effect of time-invariant firm characteristics.

3.4 Descriptive statistics

Table 2, Panel A reports our descriptive statistics. Following prior studies (e.g.,

Badertscher, Katz, and Rego 2013), we winsorize Cash ETR at zero and one, and all other

continuous variables at the top and bottom one percent. The distributions of the variables are

largely consistent with those reported in prior studies. The mean (median) value of Cash ETR is

0.242 (0.234), which are comparable to those reported in Hope, Ma, and Thomas (2013) and

McGuire, Wang, and Wilson (2014). We further observe that 84.2% of the CFOs do not serve on

the board of directors, consistent with our expectation. The mean ROA is 11.2%, which is

relatively high because we delete firms with negative pretax income, which is used as the

deflator for ETR measures. Our descriptive statistics for all the other variables are comparable to

prior studies.

Table 2, Panel B presents the Pearson correlation coefficients between Cash ETR and

explanatory variables. We find that CFO_Not_on_Board is negatively correlated with Cash ETR.

21

In addition, we find a negative correlation between Post and Cash ETR, consistent with the time

trend reported in Dyreng et al. (2016).

The correlations between control variables are generally small, except that between M/B

and ROA (0.655), cash holdings and R&D (0.537), and ROA and foreign income (0.402).

Additional analyses indicate that there are no concerns with multicollinearity.

4 Empirical Analyses

4.1 CFO fiduciary duties and tax avoidance: Tests of H1 (H1a)

We report our primary test results in Table 3. We use robust standard errors clustered by

firm to account for the potential autocorrelation in the pooled cross-sectional tests. In Column (1)

and Column (2), we use Cash ETR as the dependent variable. H1 predicts a positive association

between executive fiduciary duties and tax avoidance, and more specifically H1a predicts that

compared to control firms, the treatment firms – Delaware firms with CFOs not serving on the

board – experience an increase in tax avoidance, or a decrease in Cash ETR.

As shown in the first two columns of Table 3, we find that the coefficient on Post is

significantly negative, implying a decrease in Cash ETR, or an increase in tax avoidance. This

result is consistent with the finding in Dyreng et al. (2016) that there is an increasing trend in tax

avoidance over time. We also find that the coefficient on Delaware × Post is significantly

positive, indicating that compared to non-Delaware firms with CFOs serving on the board,

Delaware firms with CFOs serving on the board experience an increase in Cash ETR. The

coefficient on CFO_Not_On_Board × Post is not significantly different from zero.

More importantly, we find that the coefficient on CFO_Not_on_Board × Delaware × Post

is negative and significantly different from zero (p < 0.05). This result implies that compared to

22

other firms, Delaware firms with CFOs not serving on the board experience a decrease in Cash

ETR, or an increase in tax avoidance, from the pre- to the post-ruling period. This result is

consistent with H1 that executive fiduciary duties lead to a higher level of tax avoidance. The

result is also economically significant; compared to control firms, the decrease in Cash ETR

experienced by Delaware firms with CFOs not serving on the board is 0.058 (as reported in

Column (2)), or a 24% decrease from the sample mean.

In Column (3) of Table 3, we follow Armstrong et al. (2015) and adjust Cash ETR by

industry average. This measure better reflects the extent to which a firm’s tax avoidance relative

to its industry peers, because it controls for common mechanisms used to reduce explicit taxes at

the industry level. Consistent with H1 and H1a, we still find a negative effect of the ruling on

Industry Adjusted Cash ETR. Specifically, we find a significantly negative coefficient on

CFO_Not_on_Board × Delaware × Post, confirming the robustness of the baseline results. Also

the results are almost identical to those based on raw measures of cash ETR. As such, in the

following analyses, we use the raw measures of cash ETR, not industry-adjusted cash ETR.

With respect to control variables, we find results similar to those reported in prior studies.

We find that Cash ETR is positively associated with Size and ROA, and is negatively associated

with M/B, Cash Holding, NOL, and Foreign Income.

In sum, we find results consistent with H1 that executive fiduciary duties increase tax

avoidance.

4.2 Cross-sectional variation in the effect of CFO fiduciary duties on tax avoidance

In this section, we test the hypotheses on the conditions under which the effect of CFO

fiduciary duties on tax avoidance is systematically stronger or weaker.

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4.2.1 The role of corporate governance: Test of H2

H2 predicts that the effect of CFO fiduciary duties on tax avoidance is more pronounced

for firms with weaker governance. As corporate governance is multi-dimensional, we adopt four

measures of corporate governance. The first measure is Gompers, Ishii, and Metrick’s (2003) G-

Index. The G-Index has been widely used as a reverse proxy for the strength of takeover market

monitoring (e.g., Masulis, Wang, and Xie 2007; Harford, Mansi, and Maxwell 2008). A higher

G-Index means a greater number of takeover defenses, indicating weaker governance. We split

the sample by the median of G-Index and report the regression results for the two subsamples in

columns (1) and (2) of Table 4, respectively. We find that the coefficient on

CFO_Not_on_Board × Delaware × Post is insignificant for firms with lower G-index and

significantly negative for firms with high G-index (i.e., low takeover threat). As shown at the

bottom of the table, the difference in the coefficient between the high and low G-Index

subsamples is statistically significant (p = 0.001), implying that the effect of CFO fiduciary

duties on tax avoidance is stronger for firms with high G-index (i.e., firms with low takeover

threat and firms with weaker governance).

Our second measure of corporate governance is the level of product market competition.

Prior research shows that the product market competition can serve a governance role by

facilitating incentive alignment and reducing agency costs (Giroud and Mueller 2011; Karuna

2007). Following Hoberg et al. (2014), we use firms’ 10-K based product market fluidity as a

proxy for product market competition. A higher value of product market fluidity indicates greater

product market competition and thus stronger governance. We split the sample by the median

value of pre-ruling product market fluidity and estimate the regressions for the two subsamples

separately. We report the results in Columns (3) and (4) of Table 4. The effect of the ruling is

24

more pronounced for the subsample with low product market competition (i.e., weaker

governance). The difference in the corresponding CFO_Not_on_Board × Delaware × Post

coefficients between the two subsamples is significant at 5% level.

Third, we examine the moderating role of board independence. We measure board

independence as the ratio of independent directors to all directors on a firm’s board. Then, we

split the sample based on whether a firm’s board independence is above the sample median in the

pre-ruling period. As shown in Columns (5) and (6) of Table 4, the coefficient on

CFO_Not_on_Board × Delaware × Post is insignificantly negative for firms with high board

independence but significantly negative for firms with low independence level. The difference

between the two coefficients is significant at the 10% level.

Finally, we examine the moderating effect of CFO ownership. Executive ownership could

substitute fiduciary duties in aligning the interest of executives with that of shareholders. Thus,

we expect the effect of CFO fiduciary duties to be more pronounced for firms with low CFO

ownership. We split the sample based on whether a firm’s CFO ownership is above the sample

median in the pre-ruling period. In the last two columns of Table 4, we find that the coefficient

on CFO_Not_on_Board × Delaware × Post is significantly more negative for firms with low

CFO ownership than firms with high CFO ownership (p = 0.06), consistent with our expectation.

In sum, consistent with H2, these results suggest that the positive effect of CFO fiduciary

duties on tax avoidance is stronger when corporate governance is weaker, suggesting that CFO

fiduciary duties and corporate governance are substitutes in inducing CFOs to be more

aggressive in tax planning, leading to a higher a level of tax avoidance.

4.2.2 The role of pre-ruling period’s tax avoidance: Test of H3

H3 predicts that the positive effect of CFO fiduciary duties is more salient for firms with

25

lower tax avoidance in pre-ruling period. To test this hypothesis, we split the sample by the

median of the pre-ruling Cash ETR, and then estimate the regression model for the two

subsamples separately. We report the results in Columns (1) and (2) of Table 5. The effect of

CFO fiduciary duties is more pronounced and significant only for the subsample with low prior

tax avoidance. The coefficient on CFO_Not_on_Board × Delaware × Post is negative and

statistically significant (t-statistic = –2.097) in the subsample with low prior tax avoidance,

whereas the corresponding coefficient in the subsample with high prior tax avoidance is

insignificant. Further, the difference in the coefficient on CFO_Not_on_Board × Delaware ×

Post between two subsamples is significant at the 1% level. These results are consistent with H3

that the effect of CFO fiduciary duties on tax avoidance is more prominent when firms have

lower tax avoidance levels in the pre-ruling period.

4.2.3 The role of CFO power: Test of H4

In this section, we examine the moderating role of CFO power. Bebchuk, Cremers, and

Peyer (2011) argue that the ratio of an individual executive’s compensation to the total

compensation of the top five executives indicates the relative power of the executive in the

management team. Cheng, Lee, and Shevlin (2016) use a similar measure to capture the

subordinate executives’ power relative to the CEO. Following these studies, we measure a

CFO’s power and influence by the percentage of CFO compensation in the total compensation of

the firm’s top five executives. We split the sample by the median value of the measure in pre-

ruling period and estimate the baseline model for the two subsamples separately.

Table 6 reports the results. We find that while the coefficient on CFO_Not_on_Board ×

Delaware × Post is negative for both subsamples, it is only significantly different from zero for

firms with high CFO power (t = –2.206). In addition, the coefficient is more negative for the

26

subsample with high CFO power than for the subsample with low CFO power (p = 0.003). This

result is consistent with H4 that the effect of CFO fiduciary duties on tax avoidance is higher

when the CFO has more power and thus more influence on tax avoidance activities.

4.3 Additional tests

4.3.1 Falsification tests

Like other studies of exogenous shocks, the DiDiD approach largely addresses the

contemprarnous effect. One might be concerned that the results are driven by differential time-

trend for treatment and control firms. To address this concern, we perform two falsification tests

to test the robustness of the results and validity of our inferences. First, the above tests are based

on the precondition that the Gantler ruling in 2009 leads to an exogenous shock to executives’

fiduciary duties and thus drives our results. If this is the case, we should not observe similar

results if we use another year as the event year. To test whether this is the case, our first

falsification test uses year 2005 as the pseudo-event year. We replicate our main analyses with

2001-2004 as the pre-event period and 2005-2008 as the post-event period. As there is no change

in CFO fiduciary duties in 2005, we should not observe any significant results. As shown in

Panel A of Table 7, the coefficient on CFO_Not_on_Board × Delaware × Post is insignificantly

different from zero (t = –0.757), indicating that our results are not driven by confounding events.

Another assumption of our analyses is that the Gantler ruling affects corporate tax

avoidance by increasing the fiduciary duties of those non-director executives who are responsible

for tax planning (e.g., CFOs). If this is the case, we should not observe the same results if we

conduct analyses using non-director executives who are not involved in tax planning decisions

such as Vice Presidents (hereafter VPs). Thus, our second falsification test is based on VPs and

should not lead to the same results as those in Table 3. Similar to CFO_Not_on_Board, we

27

construct an indicator variable, VP_Not_on_Board, which equals one for firms in which the VP

does not serve on the board of directors, and zero otherwise. Panel B of Table 7 shows that the

coefficient on VP_Not_on_Board × Delaware × Post is insignificantly different from zero (t =

0.354). The results confirm the above conjecture, again strengthening our inferences.

Overall, the results based on these two falsification tests indicate the robustness of our

results and validity of our inferences.

4.3.2 CFO fiduciary duties and tax risk

The results above suggest that CFO fiduciary duties encourage more tax avoidance.

However, more tax avoidance might lead to aggressive tax positions and thus higher tax risk. For

example, Daniel Hemel (2015) argues that “A fiduciary duty to minimize taxes would force

directors and officers to navigate between the Scylla of tax law and the Charybdis of D&O

liability: A tax strategy that’s too aggressive might trigger penalties, while a tax strategy that’s

not aggressive enough might give rise to shareholder lawsuits.” Prior research finds that tax risk

is associated with higher stock return volatility and negative tax and financing consequences

(McGuire, Neuman, and Omer 2013; Bauer and Klassen 2014; Guenther, Matsunaga, and

Williams 2016). Thus, whether CFOs’ fiduciary duties increase tax risk is an important issue.

To investigate this issue, we follow Gallemore and Labro (2014) and use two measures to

capture tax risk: unrecognized tax benefits (UTB) and the standard deviation of Cash ETR (Std.

of Cash ETR). To examine the effect of CFO fiduciary duties on tax risk, we estimate Model (1)

with UTB and Std. of Cash ETR as the dependent variables. As shown in Table 8, we find that

the coefficient on CFO_Not_on_Board × Delaware × Post is significantly negative (t = –2.113

and –1.970, respectively), indicating that Delaware firms with CFOs not serving on the board

experience a decrease in tax risk after the Gantler ruling compared to control firms. Thus, the

28

results suggest that CFO fiduciary duties also improve tax compliance and tax risk management.

4.3.3 Alternative measures of tax avoidance

In this section, we use several alternative measures of tax avoidance to investigate the

robustness of the results. Table 9 reports the regression results. First, we use GAAP ETR as an

alternative tax avoidance measure, which is calculated as the ratio of the total tax expenses to

pretax income adjusted for special items. Graham, Hanlon, Shevlin, and Shroff (2014) find that

the surveyed executives of U.S. public firms are concerned with both the cash and book effects

of tax planning. As reported in Column (1) of Table 9, we find that the coefficient on

CFO_Not_on_Board × Delaware × Post is significantly negative(t = –2.017), consistent with

the results reported in Table 3.

Column (2) of Table 9 reports results using Current ETR as an alternative measure, which

is calculated as the ratio of the difference between total tax expenses and deferred tax expenses,

to pretax income adjusted for special items. The inferences remain the same.

Third, following Armstrong, Blouin, Jagolinzer, and Larcker (2015), we adjust firm level

effective tax rates (i.e., GAAP ETR and Current ETR) by the average tax rates of the industry

peers (i.e., Fama–French 48 industry peers). As shown in Columns (3) and (4) of Table 9, our

results remain robust.

Fourth, we adopt another measure of tax avoidance, ETR differential, computed as the

multiplication of pretax income and the difference between statutory tax rate and GAAP ETR,

scaled by lagged total assets. As Hanlon and Heitzman (2010) note, this metric is essentially a

measure of permanent book-tax differences. Our inferences remain the same, as presented in

Column (5) of Table 9.

29

Overall, these analyses indicate that the results are robust to alternative measures of tax

avoidance.

5 Conclusion

In recent years, whether executive fiduciary duty contributes to aggressive tax avoidance

has become a controversial issue. On one side of the debate, companies and their consultants

often attribute aggressive tax planning to executives’ fiduciary duties to minimize corporate

taxes and the resulting shareholder litigation pressure. On the other side of the debate, advocacy

groups are concerned about corporate tax avoidance and argue that fiduciary duties are merely

used as an excuse for aggressive tax avoidance. At the core of this debate lies the question of

whether corporate executives’ fiduciary duties contribute to corporate tax avoidance. Yet, no

prior study has provided any evidence on this issue.

This study exploits a natural experiment to examine whether CFO fiduciary duties affect

corporate tax avoidance. Specifically, a 2009 Delaware court ruling extended fiduciary duties to

executives who are not on the board of directors. Thus, this ruling leads to an exogenous increase

in those executives’ fiduciary duties. Because CFOs are primarily responsible for corporate tax

planning decisions, we focus on CFOs in the analyses. We find that after the ruling, the

Delaware firms with CFOs not on the board – the group of firms affected by the ruling –

experience an increase in tax avoidance, compared to other firms. The findings are more

pronounced for firms with weaker governance, firms with lower corporate tax avoidance prior to

the ruling, and firms with more powerful CFOs. We also find that the affected firms experience a

decrease in tax risk.

Overall, our study provides the first systemic empirical evidence that executives’ fiduciary

duties contribute to a higher level of corporate tax avoidance. Such evidence indicates that

30

besides incentive-based compensation and governance mechanisms, fiduciary duties also induce

executives to engage in more effective tax planning, leading to a higher level of tax avoidance.

31

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Appendix Variable definitions

Cash ETR = cash taxes paid (Compustat TXPD) in year t divided by pretax book income (Compustat PI) less special items (Compustat SPI) in year t;

Industry Adjusted Cash ETR = Fama-French 48 industry peers adjusted Cash ETR, estimated following the approach in Armstrong et al. 2015;

CFO_Not_on_Board = an indicator variable that equals one for firms in which the CFO does not serve on the board of directors, and zero otherwise;

Delaware = an indicator variable that equals one for firms incorporated in Delaware, and zero otherwise; Post = an indicator variable that equals one for years 2009 and afterward, and zero otherwise; Size = the log of total assets (Compustat AT) at the beginning of year t;

ROA = pretax income (Compustat PI) less special items (Compustat SPI) in year t scaled by lagged total assets (Compustat AT);

M/B = The market-to-book ratio at the beginning of year t, measured as the ratio of the market value to the book value of assets (Compustat AT), where the market value of assets equals the book value of assets (Compustat AT) plus the market value of common equity (Compustat PRCC_F × CSHO) less the sum of the book value of common equity (Compustat CEQ) and balance sheet deferred taxes (Compustat TXDB), following Kaplan and Zingales (1997);

Leverage = long-term debt for year t (Compustat DLTT) scaled by lagged total assets (Compustat AT); Cash Holding = cash and short-term investments (Compustat CHE) scaled by lagged total assets (Compustat AT);

Intangible Assets = intangible assets (Compustat INTAN) scaled by lagged total assets (Compustat AT); Capital Intensity = net PPE for year t (Compustat PPENT) scaled by lagged total assets (Compustat AT);

R&D = research and development expense in year t (Compustat XRD) scaled by lagged total assets (Compustat AT); missing values of research and development expense are set to zero;

NOL = an indicator variable that equals one if there is a tax loss carryforward (i.e., positive Compustat TLCF) during year t, and zero otherwise;

ΔNOL = change in tax-loss carryforward (Compustat TLCF) from year t – 1 to t scaled by lagged total assets (Compustat AT);

Equity Income = equity income for year t (Compustat ESUB) scaled by lagged total assets (Compustat AT); missing values of equity income are set to zero;

Foreign Income = pretax foreign income for year t (Compustat PIFO) scaled by lagged total assets (Compustat AT); missing values of pretax foreign income are set to zero;

Managerial Ownership% = the percentage of stock ownership held by the top five executives in fiscal year t – 1, according to

37

ExecuComp; G-Index = the number of antitakeover provisions adopted by the firm in fiscal year t – 1; higher index levels

correspond to more takeover protection (Gompers, Ishii, and Metrick, 2003); GAAP ETR = the ratio of total tax expenses (Compustat TXT) to pretax income (Compustat PI) adjusted for

special items (Compustat SPI) in year t; Current ETR = the difference between total tax expenses (Compustat TXT) and deferred tax expenses (Compustat

TXDI), scaled by pretax income (Compustat PI) adjusted for special items (Compustat SPI), following Donohoe (2015);

Industry-adjusted GAAP ETR

= Fama-French 48 industry peers adjusted GAAP ETR, estimated following Armstrong et al. 2015;

Industry-adjusted Current ETR

= Fama-French 48 industry peers adjusted Current ETR, estimated following Armstrong et al. 2015;

ETR Differential = (STR – GAAP ETR) × Income, scaled by lagged total assets (Compustat AT) (see Hanlon and Heitzman, 2010), where STR is statutory tax rate, GAAP ETR is defined earlier, and income is pretax income (Compustat PI) adjusted for special items (Compustat SPI);

UTB = unrecognized tax benefits (TXTUBEND) scaled by lagged total assets (AT); Std. of Cash ETR = the standard deviation of one-year cash ETR over the period t-4 to t, where one year Cash ETR is

defined as cash taxes paid (TXPD) divided by pretax income (PI) less special items (SPI). Observations with negative pretax income before special items are excluded.

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Table 1 Sample Selection This table reports the selection process for the sample.

# of

Observations

US firm not in financial and regulated industries from 2005 to 2012 44,610

Less:

Observations with missing data to calculate tax avoidance measures 7,360

Observations with missing financial information for calculating control variable 9,211

Observations with missing G-Index information 16,901

Observations with missing managerial ownership information 3,424

Firms with observations only in pre- or post-ruling period 594

Observations with fiscal years ending between January 2009 and May 2009 156

Observations with CFOs on the board in some but not in other years 60

Observations with CEOs not on the board throughout the sample period 1,584

Final sample 5,320

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Table 2 Descriptive statistics This table reports descriptive statistics on variables in Panel A and Pearson correlations in Panel B. Panel A: Descriptive Statistics on variables

N Mean Std. Dev. 25% Median 75% Cash ETR 5,320 0.242 0.184 0.117 0.234 0.326 CFO Not on Board 5,320 0.842 0.365 1 1 1 Post 5,320 0.528 0.499 0 1 1 Delaware 5,320 0.619 0.486 0 1 1 Size 5,320 7.837 1.438 6.756 7.686 8.773 ROA 5,320 0.112 0.093 0.057 0.102 0.161 M/B 5,320 2.049 1.191 1.251 1.723 2.458 Leverage 5,320 0.182 0.164 0.026 0.163 0.276 Cash Holding 5,320 0.170 0.171 0.045 0.112 0.242 Intangible Assets 5,320 0.237 0.220 0.056 0.184 0.3.57 Capital Intensity 5,320 0.261 0.227 0.097 0.189 0.344 R&D 5,320 0.034 0.053 0 0.008 0.049 NOL 5,320 0.545 0.498 0 1 1 ∆NOL 5,320 0.021 0.616 -0.000 0 0.003 Equity Income 5,320 0.001 0.004 0 0 0 Foreign Income 5,320 0.031 0.045 0 0.013 0.049 Managerial Ownership% 5,320 0.025 0.065 0.001 0.005 0.015 G-Index 5,320 9.154 2.485 7 8 9

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Table 2 (Cont’d) Panel B: Pearson correlation statistics

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) G-index

Cash ETR -0.018 -0.092 -0.038 -0.006 0.105 -0.037 -0.043 -0.126 -0.007 -0.007 -0.184 -0.102 -0.023 -0.006 -0.061 0.053 0.008 (0.18) (0.00) (0.01) (0.66) (0.00) (0.01) (0.00) (0.00) (0.62) (0.57) (0.00) 0.00 (0.09) (0.68) (0.00) (0.00) (0.57)

CFO_Not_on_Board (1) 0.146 0.031 0.038 0.017 -0.005 0.045 -0.021 -0.022 0.078 -0.002 -0.013 0.012 -0.003 0.040 -0.025 0.013 (0.00) (0.02) (0.01) (0.23) (0.71) (0.00) (0.13) (0.10) (0.00) (0.90) (0.32) (0.37) (0.80) (0.00) (0.06) (0.34)

Post (2) -0.001 0.087 -0.095 -0.114 0.027 0.046 0.021 -0.030 -0.015 0.118 0.024 -0.010 0.019 -0.002 -0.013 (0.97) (0.00) (0.00) (0.00) (0.05) (0.00) (0.13) (0.03) (0.26) (0.00) (0.08) (0.49) (0.16) (0.86) (0.32)

Dela (3) 0.087 0.012 0.034 0.049 0.053 0.085 0.002 0.058 0.053 -0.022 -0.028 0.053 -0.061 -0.134 (0.00) (0.38) (0.01) (0.00) (0.00) (0.00) (0.88) (0.00) (0.00) (0.11) (0.04) (0.00) (0.00) (0.00)

Size (4) 0.090 -0.038 0.267 -0.234 0.110 0.155 -0.147 0.015 0.030 0.161 0.250 -0.167 0.104 (0.00) (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.27) (0.03) (0.00) (0.00) (0.00) (0.00)

ROA (5) 0.655 -0.115 0.156 0.041 0.062 -0.003 -0.135 -0.015 0.083 0.402 0.003 -0.005 (0.00) (0.00) (0.00) (0.00) (0.00) (0.84) (0.00) (0.26) (0.00) (0.00) (0.81) (0.71)

M/B (6) -0.094 0.411 0.056 -0.049 0.313 -0.077 -0.009 -0.002 0.332 0.021 -0.058 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.49) (0.91) (0.00) (0.13) (0.00)

Leverage (7) -0.305 0.265 0.220 -0.174 0.076 0.011 0.068 -0.073 -0.098 0.079 (0.00) (0.00) (0.00) (0.00) (0.00) (0.42) (0.00) (0.00) (0.00) (0.00)

Cash Holding (8) -0.190 -0.319 0.537 0.019 0.000 -0.119 0.212 0.004 -0.157 (0.00) (0.00) (0.00) (0.17) (0.98) (0.00) (0.00) (0.75) (0.00)

Intangible Assets (9) -0.368 0.047 0.125 0.012 -0.021 0.005 -0.050 -0.157 (0.00) (0.00) (0.00) (0.37) (0.12) (0.70) (0.00) (0.00)

Capital Intensity (10) -0.289 -0.122 -0.010 0.094 -0.062 0.013 0.018 (0.00) (0.00) (0.45) (0.00) (0.00) (0.33) (0.19)

R&D (11) 0.096 0.028 -0.066 0.184 -0.071 -0.100 (0.00) (0.04) (0.00) (0.00) (0.00) (0.00)

NOL (12) 0.037 -0.018 0.042 -0.025 0.019 (0.01) (0.19) (0.00) (0.07) (0.17)

∆NOL (13) 0.006 0.006 -0.007 0.012 (0.66) (0.66) (0.60) (0.40)

Equity Income (14) 0.101 -0.031 0.013 (0.00) (0.02) (0.30)

Foreign Income (15) -0.103 0.044 (0.00) (0.00)

Managerial Ownership(16) -0.162 (0.00)

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Table 3 CFOs’ Fiduciary Duties and Tax Avoidance: Test of H1

This table reports the OLS regression results on the effect of the Gantler ruling that affects Delaware firms with CFOs not serving on board on tax avoidance. The dependent variable is Cash ETR in Columns (1) and (2) and industry-adjusted Cash ETR in Column (3). Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. Dependent variable = Cash ETR

(1) Cash ETR

(2) Industry Adjusted Cash ETR

(3) Post -0.065*** -0.071*** -0.070*** (-3.079) (-3.497) (-3.420) CFO_Not_on_Board × Post 0.018 0.017 0.017 (0.850) (0.804) (0.827) Delaware × Post 0.083*** 0.083*** 0.084*** (2.589) (2.700) (2.734) CFO_Not_on_Board × Delaware × Post -0.054** -0.058** -0.061** (-1.991) (-2.213) (-2.288) Size 0.069*** 0.061*** (4.792) (4.210) ROA 0.124* 0.129* (1.803) (1.879) M/B -0.012*** -0.012** (-2.636) (-2.581) Leverage -0.028 -0.022 (-0.916) (-0.706) Cash Holding -0.099** -0.097** (-2.513) (-2.484) Intangible Assets -0.025 -0.025 (-0.721) (-0.717) Capital Intensity -0.046 -0.046 (-0.905) (-0.888) R&D 0.021 -0.005 (0.095) (-0.024) NOL -0.023** -0.022** (-2.107) (-2.028) ∆NOL -0.000 -0.000 (-0.257) (-0.168) Equity Income -0.868 -0.912 (-0.559) (-0.582) Foreign Income -0.518*** -0.523*** (-3.488) (-3.531) Managerial Ownership% -0.000 -0.000 (-0.148) (-0.274) G-Index -0.003 -0.004 (-0.168) (-0.236) Firm fixed effects Yes Yes Yes Sample size 5,320 5,320 5,320 Adjusted R2 0.346 0.363 0.341

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Table 4 CFOs’ Fiduciary Duties and Tax Avoidance: The Role of Corporate Governance This table reports tests of cross-sectional variation in the effect of CFOs’ fiduciary duties on tax avoidance by corporate governance. The dependent variable is Cash ETR. Columns (1) and (2) report the separate regression results for the two subsamples split based on the full sample pre-ruling median of G-index. Columns (3) and (4) report the separate regression results for the two subsamples split based on the full sample pre-ruling median of market product competition, measured by product market fluidity. Product market fluidity is a comprehensive measure of the degree of competitive threat to a firm; please see Hoberg, Phillips and Prabhala (2014) for detailed measurement. Columns (5) and (6) report the separate regression results for the two subsamples split based on the full sample pre-ruling median of board independence, which is measured as the proportion of independent directors on the board. Columns (7) and (8) report the separate regression results for the two subsamples split based on the full sample pre-ruling median of CFO ownership. Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

(1) (2) (3) (4) (5) (6) (7) (8)

Low G-index

High G-index

High Product

Competition

Low Product

Competition

High Board Independence

Low Board Independence

Low CFO

Ownership

High CFO

Ownership Post -0.037 -0.093*** -0.040 -0.088*** -0.059** -0.080** -0.089* -0.057*** (-0.951) (-4.366) (-1.045) (-3.739) (-2.286) (-2.513) (-1.697) (-2.978) CFO_Not_on_Board × Post -0.011 0.031 -0.007 0.035 0.004 0.043 0.061 0.011 (-0.271) (1.367) (-0.182) (1.382) (0.154) (1.318) (1.180) (0.550) Delaware × Post 0.008 0.174*** 0.049 0.101* 0.081* 0.111** 0.149** 0.057* (0.183) (3.521) (1.050) (1.813) (1.792) (2.427) (2.248) (1.729) CFO_Not_on_Board × Delaware × Post 0.004 -0.156*** -0.022 -0.083** -0.048 -0.104** -0.130* -0.046 (0.083) (-3.158) (-0.909) (-1.990) (-1.242) (-2.194) (-1.900) (-1.361) Size 0.053*** 0.083*** 0.073*** 0.059* 0.059*** 0.071*** 0.077*** 0.062*** (2.616) (4.252) (3.859) (1.947) (2.922) (3.012) (3.012) (2.826) ROA 0.184* 0.049 0.171* 0.047 0.128 0.204* 0.164 0.177* (1.963) (0.478) (1.725) (0.353) (1.299) (1.792) (0.943) (1.897) M/B -0.022*** -0.001 -0.010 -0.010 -0.014* -0.011* -0.013 -0.015*** (-3.906) (-0.200) (-1.612) (-1.104) (-1.874) (-1.835) (-1.531) (-2.607) Leverage -0.110** 0.040 -0.037 0.010 -0.007 -0.039 -0.034 -0.010 (-2.479) (0.998) (-0.873) (0.169) (-0.139) (-0.720) (-0.504) (-0.207) Cash Holding -0.052 -0.144** -0.093* -0.124 -0.160*** -0.096* -0.100 -0.151*** (-1.097) (-2.288) (-1.768) (-1.411) (-2.603) (-1.722) (-1.220) (-2.969) Intangible Assets -0.002 -0.045 -0.030 -0.088 0.002 0.003 -0.027 -0.020 (-0.034) (-0.981) (-0.666) (-1.277) (0.033) (0.046) (-0.410) (-0.405) Capital Intensity 0.077 -0.145* -0.074 -0.013 -0.131 0.014 -0.042 -0.061 (1.204) (-1.865) (-1.004) (-0.140) (-1.499) (0.183) (-0.366) (-0.956)

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R&D 0.262 -0.174 -0.083 0.669 0.260 -0.123 0.141 0.126 (0.942) (-0.507) (-0.334) (0.643) (0.682) (-0.311) (0.382) (0.352) NOL -0.029** -0.015 -0.024* -0.025 -0.027* -0.026 -0.017 -0.024* (-2.041) (-0.864) (-1.655) (-1.332) (-1.703) (-1.426) (-0.860) (-1.657) ∆NOL -0.023 0.000 -0.001 0.008 0.000 0.012 -0.000 -0.001 (-0.736) (0.292) (-0.582) (0.553) (0.264) (0.455) (-0.412) (-0.707) Equity Income -1.757 0.540 0.191 -3.621* -2.064 -0.114 -1.493 -0.357 (-0.775) (0.289) (0.092) (-1.717) (-1.192) (-0.038) (-0.760) (-0.154) Foreign Income -0.314* -0.824*** -0.634*** -0.469* -0.664*** -0.537** -0.437 -0.608*** (-1.652) (-3.632) (-2.963) (-1.892) (-2.888) (-2.348) (-1.641) (-3.009) Managerial Ownership% 0.000 -0.002 -0.001 0.001 -0.007*** 0.000 -0.177* 0.000 (0.312) (-1.241) (-0.629) (0.698) (-2.709) (0.540) (-1.845) (0.048) G-Index 0.010 -0.013 -0.013 0.025 -0.037 0.019 -0.005 0.005 (0.514) (-0.521) (-0.595) (0.896) (-1.420) (0.989) (-0.255) (0.191) Firm fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Sample size 2,730 2,590 2,705 2,615 2,902 2,418 2,009 3,311 Adjusted R2 0.361 0.380 0.466 0.400 0.432 0.449 0.510 0.404 Z- statistics for the difference in coefficients 3.279*** 1.789** 1.295* 1.557* (P-value) (0.000) (0.037) (0.097) (0.060)

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Table 5 CFOs’ Fiduciary Duties and Tax Avoidance: The Role of Pre-ruling Period Tax Avoidance

This table provides the regression results of the cross-sectional variation in the effect of CFOs’ fiduciary duties on tax avoidance by the level of pre-ruling period tax avoidance. The dependent variable is Cash ETR. The full sample is split based on the mean of pre-ruling period tax avoidance. Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses.***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. (1) (2) High Pre-ruling

Tax AvoidanceLow Pre-ruling Tax Avoidance

Post -0.033** -0.095*** (-2.458) (-2.705) CFO_Not_on_Board × Post 0.017 0.013 (0.910) (0.366) Delaware × Post 0.034 0.123** (1.190) (2.296) CFO_Not_on_Board × Delaware × Post -0.016 -0.105** (-0.995) (-2.097) Size 0.017 0.102*** (0.989) (4.701) ROA 0.181** 0.116 (2.309) (1.079) M/B -0.013*** -0.014* (-2.857) (-1.837) Leverage -0.002 -0.060 (-0.049) (-1.231) Cash Holding -0.003 -0.155** (-0.062) (-2.547) Intangible Assets -0.005 -0.038 (-0.130) (-0.645) Capital Intensity -0.001 -0.098 (-0.029) (-1.098) R&D -0.173 0.226 (-0.676) (0.641) NOL -0.010 -0.034** (-0.749) (-2.060) ∆NOL -0.002 0.001 (-1.203) (0.647) Equity Income -0.677 -1.518 (-0.410) (-0.642) Foreign Income -0.424** -0.616*** (-2.202) (-2.883) Managerial Ownership% -0.001** 0.002 (-2.032) (1.029) G-Index 0.002 0.006 (0.129) (0.197) Firm fixed effects Yes Yes Adjusted R2 2,655 2,665

45

R-squared 0.399 0.341 Z- statistics for the difference in coefficients 2.393*** (P-value) (0.008)

46

Table 6 CFOs’ Fiduciary Duties and Tax Avoidance: The Role of CFO Power

This table provides the regression results of the cross-sectional variation in the effect of CFOs’ fiduciary duties on tax avoidance by the level of CFO power. The dependent variable is Cash ETR. The full sample is split based on the pre-ruling period mean of the relative CFO compensation, calculated as the proportion of CFO compensation to the total compensation of all top five executives. Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses.***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. (1) (2)

Low CFO Power High CFO Power

Post -0.037 -0.064** (-0.890) (-2.224) CFO_Not_on_Board × Post -0.048 0.024 (-1.076) (0.807) Delaware × Post 0.029 0.109** (0.494) (2.571) CFO_Not_on_Board × Delaware × Post -0.002 -0.093** (-0.032) (-2.206) Size 0.093*** 0.034 (2.897) (1.202) ROA 0.192 0.266** (1.165) (2.338) M/B -0.013 -0.014* (-1.514) (-1.663) Leverage -0.071 -0.028 (-0.952) (-0.472) Cash Holding -0.118 -0.109 (-1.403) (-1.335) Intangible Assets 0.019 0.023 (0.254) (0.358) Capital Intensity -0.071 -0.101 (-0.679) (-0.991) R&D -0.048 -0.053 (-0.087) (-0.134) NOL 0.015 -0.028 (0.667) (-1.438) ∆NOL 0.027 -0.000 (0.305) (-0.034) Equity Income 0.215 -0.103 (0.089) (-0.027) Foreign Income -0.760** -0.623*** (-2.437) (-2.693) Managerial Ownership% -0.000 -0.001 (-0.131) (-0.292) G-Index 0.003 0.011** (0.327) (0.572) Firm fixed effects Yes Yes Sample size 1,983 2,521

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Adjusted R2 0.536 0.473 Z- statistics for the difference in coefficients 2.726*** (P-value) (0.003)

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Table 7 CFOs’ Fiduciary Duties and Tax Avoidance: Falsification tests This table reports two falsification tests. The dependent variable is Cash ETR. In Pane A, the year 2005 is used as the pseudo event year. Post is defined as zero for the pre-pseudo event period 2001-2004 and one for the post-pseudo event period 2005-2008. In Panel B, we focus on vice presidents, not CFOs. VP_Not_on_Board is one if the vice presidents are not serving on the board and zero otherwise. This table tests the effects of the ruling on Delaware firms with VPs not on board. Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses.***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. Panel A: Falsification Tests based on Pseudo Event Year of 2005 (1)

Post -0.001 (-0.025) CFO_Not_on_Board × Post 0.035 (1.407) Delaware × Post 0.016 (0.391) CFO_Not_on_Board × Delaware × Post -0.030 (-0.757) Size 0.023** (1.973) ROA 0.198*** (3.652) M/B -0.019*** (-5.190) Leverage 0.023 (0.884) Cash Holding -0.068** (-2.082) Intangible Assets -0.010 (-0.339) Capital Intensity -0.022 (-0.433) R&D 0.373** (2.050) NOL -0.016 (-1.636) ∆NOL 0.002 (0.485) Equity Income -0.789 (-0.685) Foreign Income -0.404*** (-2.955) Managerial Ownership% 0.001 (0.997) G-Index -0.007 (-1.539) Firm fixed effects Yes Sample size 8,334 Adjusted R2 0.352

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Table 7 (Cont’d) Panel B: Falsification Tests Using Vice Presidents (not CFOs) (1)

Post -0.076** (-2.469) VP_Not_on_Board × Post 0.020 (0.662) Delaware × Post 0.000 (0.006) VP_Not_on_Board × Delaware × Post 0.021 (0.354) Size 0.068*** (4.706) ROA 0.119* (1.733) M/B -0.012*** (-2.614) Leverage -0.031 (-0.986) Cash Holding -0.096** (-2.445) Intangible Assets -0.023 (-0.658) Capital Intensity -0.042 (-0.831) R&D 0.009 (0.041) NOL -0.023** (-2.134) ∆NOL -0.000 (-0.259) Equity Income -0.847 (-0.546) Foreign Income -0.511*** (-3.434) Discretionary Accrual -0.000 (-0.004) Managerial Ownership% -0.001 (-0.048) G-Index -0.179 (-0.985) Firm fixed effects 0.362 Sample size 0.021Adjusted R2 (0.354)

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Table 8 CFOs’ Fiduciary Duty and Tax Risk This table reports the OLS regression results on the effect of the Gantler ruling that affects Delaware firms with CFOs not serving on board on tax risk. The dependent variable is UTB in Column (1) and Std. of Cash ETR in Column (2). Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. Dependent variable = UTB

(1)Std. of Cash ETR

(2) Post 0.006*** -0.004 (5.378) (-0.441) CFO_Not_on_Board × Post 0.001 0.007 (0.494) (0.754) Delaware × Post 0.003** 0.016 (2.077) (1.087) CFO_Not_on_Board × Delaware × Post -0.003** -0.014** (-2.113) (-1.970) Size -0.002* -0.034*** (-1.839) (-3.657) ROA 0.000 -0.189*** (0.035) (-5.165) M/B -0.003*** 0.001 (-4.743) (0.474) Leverage 0.006* 0.036* (1.706) (1.904) Cash Holding 0.005 0.027 (1.464) (1.391) Intangible Assets 0.006 0.021 (1.575) (1.042) Capital Intensity 0.012*** -0.018 (3.340) (-0.617) R&D 0.048* -0.183* (1.932) (-1.744) NOL -0.000 0.010* (-0.468) (1.938) ∆NOL -0.000 -0.001 (-0.752) (-1.251) Equity Income 0.012 0.048 (0.168) (0.095) Foreign Income 0.047*** -0.026 (3.418) (-0.347) Managerial Ownership% -0.000 -0.001 (-0.190) (-1.353) G-Index -0.001 0.000 (-1.605) (0.056) Firm fixed effects Yes Yes Sample size 4,777 5,317 Adjusted R2 0.640 0.633

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Table 9 CFOs’ Fiduciary Duties and Tax Avoidance: Alternative Tax Avoidance Measures This table reports the OLS regression results on the effect of the Gantler ruling that affects Delaware firms with CFOs not serving on board on tax avoidance, based on alternative proxies for tax avoidance. Intercept is included but not reported due to the inclusion of firm fixed effects. Please see the Appendix for variable definitions. t-statistics, computed based on firm-clustering adjusted standard errors, are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

Dependent variable = GAAP ETR

(1)

Current ETR

(2)

Industry-adjusted GAAP ETR

(3)

Industry-adjusted Current ETR

(4)

ETR Differential

(5)Post -0.067*** -0.068*** -0.068*** -0.066*** 0.003

(-3.791) (-3.746) (-3.873) (-3.653) (1.103) CFO_Not_on_Board × Post 0.047** 0.012 0.048*** 0.012 -0.005*

(2.545) (0.613) (2.615) (0.608) (-1.889) Delaware × Post 0.053** 0.056** 0.057** 0.056** -0.006*

(2.044) (2.068) (2.207) (2.076) (-1.906) CFO_Not_on_Board × Delaware × Post -0.048** -0.046** -0.051** -0.047* 0.005**

(-2.017) (-2.155) (-2.004) (-1.687) (1.988) Size 0.011 0.052*** 0.009 0.045*** -0.003*

(0.822) (3.767) (0.692) (3.271) (-1.738) ROA 0.047 -0.053 0.055 -0.036 -0.066***

(0.736) (-0.739) (0.864) (-0.512) (-4.851) M/B 0.004 0.010** 0.004 0.010* 0.001*

(0.980) (2.017) (0.968) (1.892) (1.772) Leverage -0.028 -0.059* -0.026 -0.052 0.004

(-0.926) (-1.804) (-0.867) (-1.597) (0.985) Cash Holding -0.044 -0.023 -0.041 -0.023 -0.011**

(-1.290) (-0.688) (-1.227) (-0.698) (-2.070) Intangible Assets 0.002 0.007 0.003 0.006 -0.009*

(0.045) (0.203) (0.080) (0.176) (-1.751) Capital Intensity 0.053 -0.022 0.049 -0.019 0.004

(1.035) (-0.361) (0.947) (-0.321) (0.596) R&D -0.322 -0.025 -0.336 -0.041 -0.024

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(-1.529) (-0.120) (-1.606) (-0.194) (-0.829) NOL -0.009 -0.022** -0.008 -0.020* 0.001

(-0.875) (-2.110) (-0.746) (-1.962) (0.437) ∆NOL 0.002 0.003*** 0.002 0.003*** 0.000

(1.151) (2.755) (1.217) (2.803) (0.736) Equity Income -1.482 -1.191 -1.426 -1.142 0.047

(-0.840) (-1.151) (-0.809) (-1.113) (0.254) Foreign Income -0.108 -0.370** -0.117 -0.378** -0.106***

(-0.709) (-2.407) (-0.776) (-2.509) (-4.208) Managerial Ownership% -0.000 0.000 -0.000 0.000 0.000

(-0.934) (0.243) (-0.949) (0.141) (0.182) G-Index -0.009 -0.001 -0.009 -0.002 0.001

(-0.585) (-0.098) (-0.649) (-0.116) (0.666) Firm fixed effects Yes Yes Yes Yes Yes

Sample size 5,320 5,320 5,320 5,320 5,320 Adjusted R2 0.332 0.393 0.295 0.369 0.432