Strong Corporate Governance Drives Tax Avoidance – Evidence from Germany using a Regression Discontinuity Design

This paper analyses the relationship between corporate governance and tax avoidance. This study aims to highlight the wide-ranging effects of institutional investors, which channel into corporate policy. This analysis uses a regression discontinuity design (RDD) in a two-stage instrumental variable (IV) model and takes advantage of the exogenous variation in the index membership around the index threshold. The sample comprises the firms in the German prime standard indexes. The DAX (MDAX) index consists of the largest 30 (next-largest 50) publicly listed firms by market capitalization in Germany. This paper argues that the differences in corporate governance result from the value-weighted composition of the market capitalization-based indexes. The findings show a significant discontinuity in the level of the corporate governance characteristics at the cutoff. The largest MDAX firms show stronger corporate governance characteristics compared to the smallest DAX firms. The analysis shows that strong corporate governance characteristics drive down the effective tax rate for the DAX companies. This paper contributes to existing research by establishing a causal relationship between corporate governance and taxes. The sample consists of large listed companies and the findings may not be transferrable to small- and medium-sized enterprises. The paper is the first to analyze the relationship between corporate governance and taxes for a German sample using a RDD design. This is the only paper measuring corporate governance directly in the index setting. Different from previous research, the largest MDAX firms do not show increasing tax rates upon inclusion in the DAX, where they were the smallest firms then. Instead, lower tax rates are observed