Tax avoidance and narrative disclosure tone: an ethical dimension of corporate governance

Abstract

We investigate the association between corporate tax avoidance and positive tone considering the role of audit committee in shaping this relationship in the UK context. We find that firms engaging in tax avoidance increase the positive tone of their narrative reporting, suggesting that managers opportunistically use a higher positive tone as an impression management strategy to cover-up their tax avoidance. We further show that the quality of audit committee not only deters management from providing a higher level of positive tone but also alleviates managerial incentive for impression management to conceal their tax avoidance behaviour. Our study provides empirical evidence in support of impression management through narrative disclosure tone. Moreover, it provides an ethical dimension into the monitoring role of audit committee and its role in enhancing managers’ accountability. These findings are important for stakeholders and regulators showing how managers employ impression management to cover-up tax avoidance and the effective role of audit committee. The results are robust to alternative measures and to various approaches used to address potential endogeneity problems.

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