Labor unions and tax aggressiveness $ James A. Chyz a , Winnie Siu Ching Leung b , Oliver Zhen Li c,n , Oliver Meng Rui d a University of Tennessee, USA b University of Hong Kong, Hong Kong c National University of Singapore, Singapore d China Europe International Business School, China article info Article history: Received 25 April 2012 Received in revised form 5 October 2012 Accepted 30 October 2012 Available online 13 February 2013 JEL classification: J53 H25 Keywords: Labor union Tax aggressiveness abstract We examine the impact of unionization on firms’ tax aggressiveness. We find a negative association between firms’ tax aggressiveness and union power and a decrease in tax aggressiveness after labor union election wins. This relation is consistent with labor unions influencing managers’ in one, or both, of two ways: (1) constraining managers’ ability to invest in tax aggressiveness through increased monitoring; or (2) decreasing returns to tax aggressiveness that arise from unions’ rent seeking behavior. We also find preliminary evidence that the market expects these reductions around union elections and discounts firms that likely add shareholder value via aggressive tax strategies. & 2013 Elsevier B.V. All rights reserved. 1. Introduction Do all of a firm’s stakeholders benefit when corporate taxes are reduced? While the answer to this question is potentially yes, a more interesting issue that we focus on is whether firms’ tax planning outcomes provide more or less benefit to some stakeholders or cause some stake- holders to bear more or less risk than others. Specifically, we examine an important stakeholder—labor unions— and investigate a previously unexplored link between labor unions and corporate tax aggressiveness. Because taxes are a significant cost faced by all of a firm’s stakeholders, a narrow view of corporate tax policy could lead researchers to expect firms to invest in aggres- sive tax strategies with abandon. However, as Scholes, Wolfson, Erickson, Maydew, and Shevlin (2005) point out, and recent research into the agency view of tax avoidance shows, this view ignores the effect of nontax agency costs that can negatively affect firm value (Desai and Dharmapala, 2008; Chen, Chen, Cheng, and Shevlin, 2010). More important, this view inappropriately treats diverse stakeholders as homogeneous in their utilities for tax aggressiveness without appealing to potential varia- tion in risk preferences. Prior literature suggests that labor unions have distinct incentives, political motiva- tions, and risk preferences that manifest in conservative investment and financial reporting (Faleye, Mehrotra, and Morck, 2006; Leung, Li, and Rui, 2012). It follows that the observed level of corporate tax aggressiveness could at least partially reflect labor unions’ presence and influence. More specifically, based on their incentives, political motivations, and risk preferences, labor unions likely prefer less tax aggressiveness and corporate outcomes Contents lists available at SciVerse ScienceDirect journal homepage: www.elsevier.com/locate/jfec Journal of Financial Economics 0304-405X/$ - see front matter & 2013 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.jfineco.2013.01.012 $ We are grateful for comments and suggestions from T. J. Atwood, Lillian Mills, Jeri Seidman, Leslie Robinson, Katherine Drake, Sandy Klasa, Kirsten Cook, Tim Bell, Richard Sansing, Casey Schwab, an anonymous referee, and workshop participants at the American Taxation Association 2010 mid-year meeting and American Accounting Association 2010 annual meeting. We also thank Petro Lisowsky for generously sharing with us data on tax shelter scores. n Corresponding author. E-mail address: bizzhenl@nus.edu.sg (O. Zhen Li). Journal of Financial Economics 108 (2013) 675–698