The Effect of ESG Performance on Tax Avoidance—Evidence from Korea
Round 1
Reviewer 1 Report
Dear Authors,
congratulations on your very interesting research and well-written paper. I was pleased to read the results of your analyzes. I have no objections to the structure of the paper, the formulated hypothesis, the bibliography and research methods used. I would only like to recommend extending the final conclusions and, above all, relating the results of your research to the results of other authors whom you cite at the beginning of the paper.
I wish you good luck with your further research.
Yours sincerely
Author Response
Most of all, we deeply appreciate for your precious guidance.
By following your valuable suggestion, we extended the contents of our conclusion by inserting "discussion" section, separately (Section 6). We discuss the empirical results of this work and compare them with previous results.
Thank you so much once again.
Reviewer 2 Report
Overall the paper represents valuable information regarding relationship between Korean firms’ ESG scores and tax avoidance. The paper is generally well written and structured. However, in my opinion the paper has some shortcomings in regards to both theoretical background and empirical research.
First of all, it is necessary to update the bibliography (especially in the field of publications from 2019-2021), as well as more reference to not only Korean research (review of similar studies in other countries). Moreover, some statements are not sufficiently clarified. The methodology should be described more precisely. What research period was taken into account? How many companies were investigated? Does the sample cover all chaebol-affiliated firms? How many non-chaebol firms were investigated and how they were selected? As far as empirical research is concerned, the problem may be the quite low value of the R2. However, the authors do not refer to that in the text at all.
Comments for author File: 
Comments.pdf
Author Response
Response to Referee 2
Most of all, we deeply appreciate for all of your precious comments that improve the quality our paper substantially. I made point by point revisions for each suggestion of yours. The results of our revisions are as follows.
1, Line: 40-42 “In fact, recent studies confirm the effect of taxes on financial choices, organizational form and restructuring decisions, pay out policies, compensation policies, and risk management decisions [7].
-> By following your valuable suggestion, we changed the sentence to “In fact, previous studies confirm the effect of taxes on financial choices, organizational form and restructuring decisions, payout policies, compensation policies, and risk management decisions.” . We also add another reference, Mackie-Mason (1990). [Lines 40-42]
- Corporate culture theory bibliography should be update (lines 44-47)
: By following your valuable suggestions, we also add another reference, Murray K.B (1986).
- Line: 60 -61 “Accordingly, a firm with a lower ESG score is not inclined to use tax avoidance,
which indicates a positive association between the two variables”
-> By following your valuable suggestion, we change the sentence to “Accordingly, a firm with a lower ESG score is not inclined to use tax avoidance, which potentially implies a positive association between the two variables.” [lines 60-61]
- Line: 95-96 “This finding is also in line with recent empirical studies that support negative relationships [19].
-> By following your valuable suggestion, we add two recent papers to support the argument, López-González et al. (2019), and Jones et al. (2017).
- Line: 152-175 : A much broader review of the recent empirical research should be done. Who and when investigated those issues in the world, not only in Korea?
-> By following your valuable suggestion, we add Table 1 that describes recent international evidence for the relationship between CSR performances and tax avoidance with the main variables, the sample choice, and conclusion. [Lines 153-218]
- Line: 242-245 “ However, whereas there has been a great deal of research on the interaction between CSR activities and firms' tendency for tax avoidance, the relationship is under researched in developing countries, including South Korea, probably because of the lack of reliable and comprehensive measurement of CSR practices”
-> By following your valuable suggestion, we add two additional works related to the topic of CSR effect on tax avoidance: “However, whereas there has been a great deal of research on the interaction between CSR activities and firms' tendency for tax avoidance, the relationship is under-researched in developing countries, including South Korea, probably because of the lack of reliable and comprehensive measurement of CSR practices. [31,32]”.
- Line: 275-278 “We extend the sample period significantly to obtain concrete results and highlight the importance of firm characteristics in deriving the relationship between CSR and tax avoidance”
-> By following your valuable suggestion, we directly mention the sample period of our work: “We extend the sample period significantly to totaling 7 years, from 2011 to 2017, in order to obtain concrete results and highlight the importance of firm characteristics in deriving the relationship between CSR and tax avoidance.”
- Line 332-333 “We use the BTD as the dependent variable that estimates the degree of tax avoidance, which is the most frequently used measure” Are there any other measures?
-> By following your valuable suggestion, we add other measures of tax avoidance and the reason behind the selection of BTD measure: “We use the BTD as the dependent variable that estimates the degree of tax avoidance, which is the most frequently used measure. There are other measures for tax avoidance such as the GAAP ETR (Tax Expense/Pre-tax Income) and Cash ETR (Cash Taxes Paid / (Pre-tax Income- Special Items)) [15,16]. Among them, BTD is frequently chosen because it directly measures the tendency of tax avoidance by just comparing the amount of net in-come and taxable income in a intuitive way”
- Line: 352-355. “As for the taxable income estimate (ŶT), it was difficult to obtain data directly; therefore, we used the proxy introduced by Park et al. [27], as presented in Table 1. As described in their study, the adjusted tax expense is multiplied by different tax rates determined by the government”
-> By following your valuable suggestion, we place additional explanation with regard to tax expenses: “To be specific, taxable income is estimated based on firm’s tax expense and its tax base amount as well as progressive tax rate accordingly. The calculation method is the following:
ŶT = (Tax Expense/1.1 – tax base amount (in Won) x tax rate)/progressive tax rate + tax base amount”
- Line: 419-426 “We adopt the ordinary least squares method (OLS) to estimate our empirical models in line with Huseynov and Klamm [12]”
-> By following your valuable suggestions, we deliberately explain the choice of OLS method in our estimations: “We adopt the ordinary least squares method (OLS) to estimate our empirical models in line with Huseynov and Klamm [15] and many others [31,33]. The ordinary least square method is widely used in the literature because of its robustness from the fact that the method relies on a limited set of assumptions to obtain consistent estimators. Because a firm’s financial variables for a fiscal year is substantially affected by firm specific events such as mergers and acquisitions, managerial turnovers, and the outcome of R&D projects, the ordinary least square method is known to be one of the best methods to test empirical hypotheses with financial variables”
- Line 440-450. “Finally, we conduct a subsample analysis based on the categories of chaebol and non- chaebol affiliates”.
-> By following your valuable suggestions, we provide detailed information related to our subgroup choices: “Finally, we conduct a subsample analysis based on the categories of chaebol and non-chaebol affiliates. Specifically, from FNguide, we downloaded all data for Korean listed firms between 2011 and 2017, and selectively chose those affiliated with chaebols, as defined by the KFTC, and assigned them to a chaebol group. Because the ESG score pro-vided by KCGS covers all the sample of firms listed in the KOSPI market, the biggest stock exchange in Korea, the subgroup of chaebol affiliates covers almost all of the chaebol affili-ates the listed the KOSPI market except a small set of companies with impaired observa-tions. The remaining firms were assigned to the non-chaebol group. We estimate the above two empirical models separately for chaebol and non-chaebol affiliates. For our analysis on totaling 5,612 firm-year observations, 1,472 firm-year obsevations were assigned to chaebol group and 5,196 firm-year observations were assigned to non-chaebol group.”
- Table 5-7: Low R-square problem
-> By following your valuable suggestions, we describe that our R-square value can be considered as low value. We also mention that this low R-square value is in line with the extant studies as well.
- Is should be the section 6. Discussion to compare the paper results with previous empirical
studies
-> By following your valuable suggestions, we add section to discuss our empirical results and to clarify the contribution of our paper to extant literature
- Line 632-635 “The coefficients on the ESG variables become more negative in the non-chaebol affiliate sample than in the chaebol affiliate sample.” What does it mean “ to become more negative”?
-> By following your valuable suggestions, we elaborate our explanation: “The coefficients on the ESG variables turn out to be significantly more negative in the non-chaebol affiliate sample than in the chaebol affiliate sample, indicating that the role of CSR practice in the reduction of tax avoidance is stronger within the non-chaebol affiliates.”
Author Response File: 
Author Response.docx
Reviewer 3 Report
Dear Authors,
Congratulation on your paper.
Some recommendations:
- English is well written, but formatting should be thoroughly revised.
- line 160, edit “avoid tax avoidance”
- line 215, do you really mean “samples” or just one sample?
- line 236, Do you have to mention “in general” on H1? By econometrics, it is already in expected value. It comes across as a pleonasm.
- lines 288 to 295: several words are connected and require a space.
- lines 318 and 319: the sentence doesn´t make sense economically.
- Format tables 3, 4, 5 and 6, numbers and variables names are messed up and subtitle is not properly formatted.
- In terms of the literature and results, I would recommend the following:
- Lines 30 to 35 require a citation;
- Lines 54 to 61: I don’t agree that CSR is a theory, but rather an area of research. Informing theories are usually Stakeholder or legitimacy theory or agency theory. I would feel the need to review the text on the mentioned lines;
- Regarding H3 (lines 247-248), I find difficult to understand why you would consider social score as most relevant on mitigating tax avoidance. In fact, extant literature as pointed governance score as most relevant in moderating managers’ tax avoidance. I am not totally convinced by your arguments. Can you please strengthen the support for this H?
- On top of the previous, I find it even more difficult to understand why you would find a positive association between governance score and BTD. Can you elaborate on that? Are you not controlling properly for some omitted economic phenomena?
- In order to provide better help in figuring out the previous results, I miss a proper discussion of BTD. You mention a rate but you do not provide any BTD description showing what should be the denominator of that variable. Is it a currency absolute amount?
- Please explore further and explain your results discussion in lines 417-423 and 447-452.
I enjoyed your paper.
Author Response
Response to Referee 2
Most of all, we deeply appreciate for all of your precious comments that improve the quality our paper substantially. I made point by point revisions for each suggestion of yours. The results of our revisions are as follows.
Part 1. Editing English
The specific line number is different because of our revision. We specify the line number in this response based on the revised version of our paper.
line 161: avoid tax avoidance
: avoid tax manipulation
line 268 : do you really mean “samples” or just one sample?
: samples -> the sample of
line 290~291, Do you have to mention “in general” on H1? By econometrics, it is already in expected value. It comes across as a pleonasm.
: We deleted the phrase of “in general”
lines 376 to 383: several words are connected and require a space.
: As shown in the phrase of “Tax Expense: Income Tax Expense + (△deferred tax asset - △deferred tax liabilities)”, we make some spaces.
lines 399 and 400: the sentence doesn´t make sense economically.
: Next, we control for firms’ investment and operating cost structures to test our hy-potheses. Firms in capital-intensive industries could have a lower tax rate because of the substantial depreciation from capital expenditure; therefore, we use capital expenditure divided by total assets, namely CapExp, to control for this effect. The price-to-book (PB) ratio is also introduced to capture a firm’s investment opportunities as well as industry het-erogeneity. A firm’s higher PB ratio indicates a greater investment opportunity in the fu-ture or the firm’s inclusion in capital intensive industry”.
- Format tables 3, 4, 5 and 6, numbers and variables names are messed up and subtitle is not properly formatted.
: We changed them properly.
Part 2. Literature Review
Lines 30 to 35: require a citation
: We cited the following paper: Gillian, S.L.; Kock, A.; Starks, L.T. Firms and social responsibility: A review of ESG and CSR research in corporate finance. Journal of Corporate Finance. 2021, 66, 1-16.
Lines 55 to 62: I don’t agree that CSR is a theory, but rather an area of research. Informing theories are usually Stakeholder or legitimacy theory or agency theory. I would feel the need to review the text on the mentioned lines
: another branch of CSR theory -> some researches in the areas of CSR suggest
Regarding H3 (lines 327-328), I find difficult to understand why you would consider social score as most relevant on mitigating tax avoidance. In fact, extant literature as pointed governance score as most relevant in moderating managers’ tax avoidance. I am not totally convinced by your arguments. Can you please strengthen the support for this H?
On top of the previous, I find it even more difficult to understand why you would find a positive association between governance score and BTD. Can you elaborate on that? Are you not controlling properly for some omitted economic phenomena?
: (lines 309-325) To answer the above two comments, we insert the following two paragraphs. We clarify that a good governance structure could be closely associated with lower managerial diversions. Thus, it is also possible that a manager tries to manipulate tax liabilities to increase operating performance and to enhance the shareholder value of corporations.
“Of course, self-interested managers have incentives to reduce the likelihood of tax avoidance with good governance structure, especially in terms of effective auditing system. However, if a firm’s good governance indicates a stronger monitoring process that pre-vents managerial diversions, it is possible that a good governance structure is positively related to the tax avoidance. This is because the tax avoidance could increase operating profits of a corporation, which may enhance the shareholder value of firm. As far as managers could not divert the firm’s profits to their pockets, tax avoidance could have positive valuation effects and could become a corporate policy in line with the interests of shareholders. Thus, a good governance structure from the perspective of effective monitoring process could be positively correlated with the tendency of tax avoidance.
The Korean market strengths a firm’s internal monitoring process after the financial crisis of 2008 and the Asian crisis of 1997 mostly by expanding the role of independent director in monitoring managerial diversions. Such stronger monitoring system may pro-vide additional incentives of tax manipulation for the CEOs, which may enhance the shareholder value of corporations. Accordingly, we expect the most significant role of social score in deciding tax avoidance for the Korean corporations compared to that of the environmental or governance score.”
In order to provide better help in figuring out the previous results, I miss a proper discussion of BTD. You mention a rate but you do not provide any BTD description showing what should be the denominator of that variable. Is it a currency absolute amount?
: Yes, this one is currency absolute amount, which is widely used in the literature of tax avoidance. Of course, the size effect of corporation probably matters in the estimation. However, the ratio variable such as the net-income to taxable income could be seriously biased as well. The firms with near zero taxable income or net income could have massively large value of tax avoidance measures. In line with corporate finance literature, standardizing the current BTD value by dividing total assets could be a solution. This solution is not a perfect one as well because it may place emphasis too much on the value of total assets. Accordingly, Cho and Yoon [33] and other papers use the absolute amount of BTD as the benchmark measure of tax avoidance within a short period of time. We basically follow their approach.
Please explore further and explain your results discussion in lines 417-423 and 447-452.
: As you suggested, we explain the estimation results more clearly. For instance,
Lines 513-530: These robust results contrast with the results of empirical models that incorporate environmental and governance scores. Without controlling for the social and governance scores in the third column, the individual component of the environmental score had a significantly negative effect on the tendency to manipulate tax. However, the coefficient even becomes positive at 0.09 after controlling for the environmental and governance scores in the second column. This finding suggests that the environmental score has limited power in explaining the degree of tax avoidance consistent to its purpose to measure the environmental performance of a corporation. The significant correlation between the environmental and social scores may drive the negative relation. The environmental score itself does not seem to provide additional dimension of information related to tax avoidance if the social score is controlled as shown in the second column.
The governance score is rather positively related to the tendency of tax avoidance. This finding seems to be closely associated with the value enhancing aspect of tax avoidance with limited managerial diversions. A greater governance structure indicates a lower level of managerial diversion. A manger in this type of good governance firms is prone to manipulate tax because tax manipulation could enhance the financial performance and the value of a corporation. Significantly positive coefficients on the governance structure are in line with this value-enhancing aspect of tax manipulations.
Lines 565-573 : It is also interesting that the governance structure itself becomes less significant factor in deciding the tendency of tax manipulation. Such a lower tendency for the chaebol affil-ates with good governance firms is in line with the explanation based on the managerial diversion as argued above. The positive association between a better governance structure and the tendency of tax avoidance could be more significant when the managerial diversion is well controlled by the monitoring procedure. Chaebol affiliates are widely known to experience more severe managerial diversion because of its ownership structure concentrated on specific families. Such innated managerial diversion problem may weaken the linkage between good governance structure and the likelihood of tax avoidance.
Author Response File: Author Response.docx
Round 2
Reviewer 3 Report
Dear authors,
congratulations on the signicant improvement of your paper.
