Financial constraints, corporate tax avoidance and environmental, social and governance performance

Abstract

Purpose

This paper aims to investigate the relationship between corporate tax avoidance and environmental, social and governance (ESG) performance and the moderating effect of financial constraints on the relationship between corporate tax avoidance and ESG performance.

Design/methodology/approach

The sample consists of a global data set involving 24,259 firm-year observations from 49 countries for the years 2011–2020. Corporate ESG performance was extracted from the Thomson Reuters database. The book-tax difference model was used for measuring corporate tax avoidance, while financially constrained firms were identified using the Kaplan and Zingales (1997) index.

Findings

The results show that firms with higher tax avoidance are associated with higher ESG performance, but lower ESG performance is shown for firms with higher financial constraints. The results further indicate that the positive impact of corporate tax avoidance on ESG performance becomes weaker for firms with higher financial constraints.

Practical implications

The findings imply that policymakers and regulators should focus on mechanisms to promote more internal funds to assist firms in pursuing ESG-related initiatives, such as through tax incentives. Investors should understand the “smokescreen” effect of corporate tax avoidance on ESG performance, especially for firms with financial constraints.

Originality/value

This analysis provides international evidence on the link between tax avoidance and ESG and considers the joint effect of pressures for internal funds, through tax and financing constraints, on corporate ESG performance.

Citation

Mohamad Ariff, A., Kamarudin, K.A., Musa, A.Z. and Mohamad, N.A. (2024), "Financial constraints, corporate tax avoidance and environmental, social and governance performance", Corporate Governance, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/CG-08-2023-0343