Controlling Shareholders' Incentive and Corporate Tax Avoidance: A Natural Experiment in China

The split share structure reform removes a significant market friction in China's capital market by allowing previously non-tradable shares to be freely tradable at market prices. Such a reform reduces the agency conflict between controlling shareholders and minority shareholders as the former now care more about stock prices. We find that state-owned firms, but not non-state-owned firms, significantly increased their tax avoidance activities after the reform. We attribute this differential effect to the dual role of the government as state-owned firms' controlling shareholder as well as the tax claimant. Further, this effect is more pronounced for state-owned firms that are more likely to be influenced by the government prior to the reform. Finally, the reform reinforces a positive association between tax avoidance and firm value. Overall, our study suggests that when controlling shareholders are more concerned about stock prices, state-owned firms engage more in tax avoidance activities to enhance firm value.