Opportunities to Divert, Firm Value, and Taxation: Theory and Evidence from European Firms

Abstract

We study the relationship between opportunities for managerial diversion, corporate tax system parameters, and the return on shareholder funds. Theoretically, in a simple game between corporate insiders and outsiders, higher costs of diversion increase the return. European firm-level data lend support to these results. Further, in civil-law countries an increase in the corporate tax rate has a positive effect on shareholder value, whereas in common-law countries it has a negative effect.