Does Tax Enforcement Deter Managers’ Self-Dealing?

Abstract

This study examines the effect of corporate tax enforcement on managerial self-dealing, with a focus on manipulated gifts of insider stock. Prior work suggests that managers employ a variety of manipulative techniques to maximize their personal tax benefits from donating corporate stock, such as strategically timing gifts based on private information and fraudulently backdating gifts to the date with the highest price (Yermack, 2009; Avci et al., 2016). Building on prior literature suggesting that the tax authority can discipline managerial misconduct, we hypothesize that IRS scrutiny from a corporate tax audit raises managers’ perceived risk of detection, who refrain from making manipulated stock gifts while the firm is under audit. Using a novel, firm-specific measure to identify firms under audit, we find direct evidence that heightened scrutiny from tax enforcement serves as an effective monitoring mechanism and reduces managers’ self-dealing behavior.