The effect of tax avoidance on discretionary expenses: evidence from Korea

Abstract

This study investigates the relation between tax avoidance and discretionary expenses. The object of this study is to present the empirical evidence on whether additional cash from tax avoidance is used on discretionary expenses. Tax avoidance is estimated using the model suggested by Desai and Dharmapala (2006). Discretionary expenses are estimated using the index suggested by Roychowdhury (2006), which are selling and administrative expenses except taxes and dues, depreciation expenses, amortization expenses, rent expenses and insurance expenses because the management cannot manage these expenses discretionarily. Research expense and ordinary development expense are included in discretionary expenses. The empirical results of this study are as follows. First, tax avoidance is positively associated with discretionary expenses. This result means that the management spends additional cash from tax avoidance on discretionary expenses. Second, the ownership percentage of foreign investors weakens the positive relation between tax avoidance and discretionary expenses. This result suggests that foreign investors monitor the management’s discretionary decision effectively. Third, the positive relation between tax avoidance and discretionary expenses is weakened as the ownership percentage of a major stockholder increases