Big-headed CEOs use more tax shelters: Research

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Big-headed CEOs could be partly to blame for the type of tax sheltering the U.S. is now going after, new research suggests.

A paper published last week in the Journal of the American Taxation Association suggests that companies with relatively narcissistic CEOs are 3.9 percent more likely to seek out and use corporate tax shelters than firms with low-narcissism CEOs. The research joins a growing field of study examining individuals' behavioral tendencies and their effects on corporate policies.

"Pulling out the characteristics of the firms, having a narcissistic CEO as opposed to a non-narcissistic CEO, they will have influence on the tax policy," said Kari Joseph Olsen, an assistant professor at Utah State University and a co-author of the paper. "We found that they indeed have a 2 to 3 percent lower tax rate."

The authors used a measure of narcissism that was developed for previous studies. The composite index (NarcScore) includes relative cash and noncash pay in addition to the prominence of the CEO's photograph included in the firm's annual reports. A CEO whose picture occupies a whole page in the report scores higher in that regard than one photographed in a group or a picture that takes up less than half a page, for example.

Individual effects

"Often times we think of these things as firm effects," Olsen said. "That regardless of who the executive is, they might not have the knowledge or the experience." But the research shows an individual effect: A narcissist in charge can shift tax policy to more aggressive forms of sheltering and avoidance, and the characteristics are of the person, not the institution.

"If a CEO is at one firm and moves to a new firm, the narcissism level remains the same," Olsen said.

The researchers point to two avenues through which CEOs affect tax policy: By setting a "tone at the top" of an organization that promotes risk-taking behavior either through policy choices or hiring top executives with similar attributes; and, CEOs can have direct involvement in a firm's tax management strategy. They point to prior research that shows individual CEOs have significant impact on those strategies but doesn't document any causal characteristics.

Narcissism might seem like a subjective attribute with which to measure corporate heads, but there's a growing body of literature that studies behavioral tendencies and their effects on corporate decision-making. Narcissists tend to be overly assured of themselves and display inflated views of their abilities that leave them immune to criticism and self-doubt.

A version of the measure that Olsen and his co-author James Stekelberg, an assistant professor at the University of Arizona, used was developed for a 2007 paper that found companies with narcissistic CEOs saw more dynamism and larger acquisitions than other companies. While the research suggests a propensity for bold action, the companies didn't outperform other firms in the market.

"They're taking advantage of the way the tax code is written." -Kari Joseph Olsen

Narcissism is often regarded as a negative trait, and narcissists are seen as self-centered and not dissuaded from self-aggrandizing, even after personal failure. But the researchers are quick to point out that those same attributes can be helpful in the corporate world. They wrote that "narcissists often succeed at ascending corporate ladders because in addition to their dark-side traits, they also exhibit positive characteristics such as being achievement driven, charismatic and confident."

Because information on a company's tax sheltering isn't normally publicly available, the researchers used a previously developed method for predicting whether a company uses corporate tax shelters. The model predicts the likelihood that a firm uses tax sheltering based on the company's book-tax differences, leverage, size, return on assets, foreign income, and research and development intensity.

The research found a significant positive correlation between their NarcScore and the sheltering probability.

To check their results, they also looked at the firm's uncertain tax benefits, which companies have had to report since 2006.

Lastly, they calculated a long-run cash-effective tax rate based on the CEO's second and third year of tenure. If there were an narcissism effect, the ETR should be lower than expected and negatively correlated with the NarcScore. Indeed, the research found that firms with high-narcissism CEOs have average cash ETRs around 3.4 percent lower than those with low-narcissism CEOs.

Legal under the tax code

The researchers didn't look at the types of tax shelters specifically, but rather their effects on firms' tax burdens. But the types of shelters that would be included range from buying tax-free municipal bonds to lower their burden to the complex multinational deals like corporate inversions. The Treasury Department on Monday announced new regulations to crack down on tax inversions, in which a U.S. company acquires a smaller foreign competitor and moves its business address to take advantage of lower tax rates.

Most often, there's nothing illegal about tax shelters.

"They're taking advantage of the way the tax code is written," Olsen said. The millions of documents on international tax havens leaked in the Panama Papers are not accusations of criminality, but it can still be distasteful to be associated with questionable accounting practices.

"It's not necessarily good or bad," Olsen said. "There's characteristics of a narcissist that helps them build things, rally the troops."

A narcissist in the C-suite could be good for a firm looking for quick expansion or to move into new markets. It's up to the corporate board to decide, Olsen said, "When is this a good thing, when is it a bad thing?"