Privatization, tunneling, and tax avoidance in Chinese SOEs

The purpose of this paper is to investigate the effect of ownership structure arising from China’s unique privatization process on listed firms’ tunneling activities and their interaction with tax avoidance.

Using hand-collected data on the incompletely restructured state-owned listed firms and their applicable tax rate, this paper conducts a multivariate regression to test research questions. It also employs a triple differences method to examine whether the observed interaction between tax avoidance and tunneling is mitigated for well-governed firms.

It documents that controlling shareholders’ tunneling increases as the percentage of shares owned by state-owned enterprises (SOEs) increases. Evidence also shows that the magnitude of tunneling increases when SOEs controlled by the central government engage in more tax avoidance, suggesting that these firms use tax avoidance to facilitate wealth expropriation.

These findings advance the understanding of the tunneling incentive behind the tax avoidance behavior for a subset of Chinese SOEs and have implications for emerging capital markets that are characterized by concentrated government ownership and weak corporate governance.

This paper is the first paper to investigate the effect of the incomplete privatization process on tunneling and the interaction between tunneling and tax avoidance activities. It extends prior studies by investigating the incentives behind SOEs’ tax avoidance from the perspective of an agency problem and documenting that good corporate governance plays an important role in deterring the diversionary tax avoidance.