1. Introduction
This paper investigates whether and how a supplier’s customer geographic proximity affects supplier tax avoidance. Corporate tax burdens firms globally, and firms have strong incentives to engage in tax avoidance activities in their tax planning strategy [
1]. Existing studies have found that different stakeholders, such as external auditors [
2], analysts [
3], and institutional investors [
4], may affect the motivations of corporate tax avoidance. There is an increasing awareness that tax avoidance is also noticeably influenced by a firm’s tax planning strategies via the supply chain [
5,
6]. Recently, implementing tax avoidance strategies via the supply chain has captured the attention of scholars and policymakers. A famous practical example is that of the industrial manufacturer Caterpillar, who, according to a Senate report in 2014, shifted billions of dollars in profits by tax planning related to its supply chain to avoid paying USD 2.4 billion in taxes in the U.S. Existing theoretical studies have mainly focused on firms’ tax strategies in terms of the global supply chain strategy of using the tax rate gap between different countries [
6]. Chen and Lin [
3] have extended the incentive of tax avoidance to include information asymmetry between firms and stakeholders. However, as an important signal of the corporate information environments, customer geographic proximity has been overlooked in related research. This can directly affect the cost of information exchange in the supply chain and has been ignored in prior tax-related studies (see Hanlon and Heitzman [
1] for a review). The purpose of this study is to fill this gap by studying the impact of the geographic proximity of a supplier to its customers on corporate tax avoidance.
Whether customer geographic proximity affects suppliers’ tax avoidance is an empirical question. Intuitively, customers who are proximate to the supplier incur lower costs of information processing and exchange via the supply chain [
7,
8], which provides opportunities for a supplier firm and its customers to build a closer strategic alliance in tax avoidance [
6]. In this way, a supplier with geographically close customers would have an information advantage that might provide more incentive for collusion in tax avoidance than one with geographically remote customers. However, from the supplier’s information environment perspective, customers proximate to the supplier also make information search costs lower for outside stakeholders, such as analysts [
9,
10], auditors and regulators [
11,
12], helping them to easily acquire corporate operating and tax-related information This generates more transparent information from the supplier and increases the risk of detection from regulators, thus decreasing their incentives to engage in tax avoidance. Compared to geographically close customers, geographically remote customers are largely opaque to outside stakeholders [
13], providing opportunities for firms to engage in tax avoidance free from monitors. Furthermore, customers’ geographic proximity to their suppliers may be optimal for them to monitor their suppliers’ tax avoidance activities. Customers would do this to ensure that their own supply chain remains uninterrupted and thus decrease the extent of the supplier’s tax avoidance. Overall, it is, ex-ante, unclear how customer geographic proximity might affect supplier tax avoidance.
Further, how customer geographical proximity affects supplier tax avoidance is also an interesting and important question to be explored. Existing literature shows that the information environment is an important consideration when firms conduct their tax avoidance strategies [
3]. We investigate the potential channels for tax avoidance and provide a further empirical explanation of how a supplier’s information environment affects its tax avoidance. In addition, the motivations for the supplier to engage in tax avoidance may vary across different corporate, industry, and market characteristics, which may also be interesting to explore further.
The context of China helps us to test the research question. First, globally, China has the second-largest land area (
https://www.worldometers.info/geography/largest-countries-in-the-world/, accessed on 1 January 2022), which provides suppliers with potential opportunities to choose geographically close or remote customers in a consistent setting that allows us to control for other factors, such as regulation and culture, compared with cross-country analyses. The geographic distance between the suppliers and customers provides sufficient within-country variations to identify the real effect of customer geographic proximity on suppliers’ tax strategies. Second, although research on corporate tax avoidance from a perspective of specific strategies that require the cooperation of other parties has been carried out in a China context (see Tang [
14] for a recent review), little is known about the role of the customer. China provides an appropriate setting because listed Chinese firms offer voluntary disclosure of information on their top five customers. Third, The State Council issued the Law of the People’s Republic of China to administer the levying and collection of taxes in 1993 (hereafter,
Taxes Collection Act). This law is the first special law for the levying and collection of taxes issued after the founding of the People’s Republic of China, a law that the tax authorities must obey. It requires regulators to carefully verify suppliers’ tax-related information, particularly repeated transactions between suppliers and their major customers. This is achieved by sending letters or conducting on-site supervision. Consequently, China’s unique geographic characteristics and institutional features provide excellent opportunities to investigate our research question.
Using a sample of 5135 firm–year observations of 1430 listed Chinese firms and their top five customers from 2009 to 2020, we found a positive association between major customers’ weighted geographic distance and their supplier’s extent of tax avoidance. Furthermore, we employed a quasi-natural experimental approach, Heckman two-step and entropy balancing methods, to mitigate endogeneity concerns. Finally, we used alternative measures, changed the standard error estimation method, changed the fixed effect, and considered the impacts of the 2008 financial crisis, the value-added tax (VAT) reform in 2016, and the effects of customer concentration to corroborate our main findings. The results are consistent across all additional robust tests.
Furthermore, we uncover two underlying mechanisms. First, the information asymmetry channel supports that the customer geographic proximity can weaken the supplier–customer relationship information advantages through a convenient way for outside stakeholders to simultaneously acquire related information of the supply chain, reducing supplier tax avoidance. Second, the detection risk channel that supports customer geographic proximity can lessen the scrutiny cost of regulators, increasing the risk of detection associated with supplier tax avoidance activities, thus reducing managers’ impetus to engage in tax avoidance. Using the different functions between the supplier office address and the registered address, we further rule out the potential concern exerted by customer monitoring.
Finally, we examine the moderating effects and find that the positive relationship between the major customers’ weighted geographic distance and supplier tax avoidance is more pronounced for suppliers at high financial risk in competitive industrial sectors and weak marketization environments.
Our findings may have several contributions. First, we extend to the literature on the determinants of corporate tax avoidance from the supply chain perspective. Prior studies have examined the shareholders, managers, auditors, and analysts are factors that can explain the variation of corporate tax avoidance [
4,
15,
16,
17]. Recent literature extends the factors on tax avoidance to the supply chain and finds that suppliers with more concentrated customers or closer customer relationships are more likely to engage in tax avoidance [
5,
6]. Our research extends this literature by focusing on the supplier–customers relationship from the geographic localities within-country perspective and provides evidence that customer geographic proximity can reduce supplier tax avoidance. In addition, many prior studies have explored the channel of tax avoidance through the supply chain, mainly focusing on the strategy with customers through subsidiary recognition in low-tax jurisdictions (see Cen, Maydew, Zhang and Zuo [
6]). Our study from a within-country perspective on how customers’ geographic location may affect the supplier firms’ tax avoidance strategy provides a clean setting to eliminate other factors such as regulation and tax jurisdiction across countries.
Second, our study contributes to a growing literature on the economic consequences of the firm’s stakeholder geographic proximity on its corporate decisions [
18,
19,
20,
21,
22], especially the supplier–customer geographic relationships on supplier decisions, such as innovation, stock price crash risk and risk-taking [
8,
23,
24]. We complement the existing research by focusing on the effect of supplier–customer geographic proximity on tax avoidance, which represents a corporate decision that is highly influenced by corporate information transparency and agency problems [
3,
25,
26]. Moreover, evidence on customer geographic proximity shows that customers’ geographical proximity may help customers monitor supplier behaviors and thus increase suppliers’ corporate governance [
23]. Our findings give another perspective that customers’ geographical proximity may also help related outside stakeholders monitor supplier’s behaviors through obtaining more supply chain information, which also increases corporate governance and sustainable management. This may also provide some theoretical and practical implications for researchers and policymakers.
Third, our study also contributes to a growing strand of research that links the firm’s information environment to its tax avoidance decisions. Existing scholars find that information environments, such as financial transparency and analyst coverage [
3,
25], can affect corporate tax avoidance by alleviating information asymmetry between firms and outside stakeholders. However, very few explore the firm’s tax avoidance strategies from the supply chain information environments, reflected by the geographic proximity between the supplier and its customers. Our investigation of the two potential mechanisms pointedly further provides an empirical explanation of how the supplier’s information environment affects its tax avoidance. We find that customer geographic proximity helps the outside stakeholders conveniently and cheaply acquire corporate operating and tax-related information, generating more transparent information from the supplier and detecting risks from regulators. We expect these findings to inform a new viewpoint on monitoring corporate tax avoidance among auditors, tax authorities, and policymakers.
The remainder of this paper proceeds as follows.
Section 2 introduces the literature review and hypotheses development.
Section 3 describes the data and research design.
Section 4 presents the baseline results along with various tests to address the endogeneity problems.
Section 5 discusses possible underlying mechanisms.
Section 6 offers moderate effects tests, and
Section 7 provides additional analyses.
Section 8 summarizes and concludes.
8. Conclusions
Despite increasing awareness about the effect of the supplier–customer relationship on supplier tax avoidance, geography has mostly been ignored in the literature on tax avoidance via the supply chain. Our paper uses a sample of listed Chinese firms and their top five customers’ information to investigate the impact of customer geographic proximity on the supplier’s tax avoidance. We find that the geographic distance between a supplier and its major customers has a positive and significant effect on its tax avoidance. Our findings are robust after considering endogeneity concerns by examining an exogenous variation in customer geographic distance following the operation of HSR in the near supplier firm for the first time, performing the Heckman two-step method to mitigate the concern of selective bias, and employing the entropy balancing method to alleviate non-random treatment assignment bias due to observables. Our findings are still consistent in additional robust tests.
We also find support for the two potential mechanisms that underline the impact of the customer geographic proximity on supplier tax avoidance: the information asymmetry channel, by which the farther customer geographic distance from the supplier aggravates the suppliers’ information asymmetry between the supplier firm and other outside stakeholders that are positively related to supplier tax avoidance; and the detection risk channel, by which the farther customer geographic distance from the supplier lessens the detection risk for the supplier and is thereby positively related to supplier tax avoidance. We also provide evidence that filters out the potential concern of our baseline results driven by customer monitoring. Furthermore, our results suggest that this effect of customer geographic proximity on supplier tax avoidance is stronger in supplier firms with high financial risk, supplier firms in a competitive industry, and supplier firms in an operating area with weak marketization environments.
Overall, our study sheds light on the role of customer geographic proximity in affecting the supplier’s tax avoidance decisions. From the impact of a firm’s characteristics on corporate tax planning, our findings provide a shred of clear evidence to better understand the debate on the pros and cons of the customer geographic localities within-country for the supplier.
8.1. Theoretical Contributions and Practical Implications
This study has implications for the theoretical literature and management. First, our study adds to the growing literature on related stakeholders and tax avoidance. The existing evidence shows that firms’ relationship with auditors and analysts can affect their tax avoidance [
2,
3]. We supplement prior studies on tax avoidance by identifying a new factor—supply chain—especially customer geographic distance, which has an incremental effect on tax avoidance. Second, we extend the studies on the effect of the supplier–customer relationship on the corporate decision. Much research has explored the characteristics of customers on a supplier’s corporate governance, such as customer concentration, but few focus on the impact of geographic location [
8,
23,
24]. We complement the existing research by focusing on the effect of supplier–customer geographic proximity on tax avoidance, which is highly influenced by corporate information transparency and agency problems [
3,
25,
26]. Third, we also contribute to the literature about the benefits of information spillover of a firm’s supply chain to the information environment. Specifically, we explored how outside stakeholders use the firm’s supply chain information because the reduced distance to customers affects the supplier’s tax avoidance decisions.
The practical implications of this paper are mainly manifested in two aspects. The first concerns management decision face a trade-off when choosing the remote customer. Our empirical research evidence shows that geographic proximity to customers may improve the information environment as well as higher tax detection risk, which provides implications for management. The second concerns the policymakers, such as tax regulation. The supplier may use information advantage for the customer over tax jurisdiction to engage in tax avoidance. Therefore, policymakers should pay attention to tax avoidance through the supply chain.
8.2. Limitations and Future Research Directions
This study also has some limitations. First, we only investigate the customer characteristics of geographical location, which might only account for part of the reason for tax avoidance. Further studies could consider other customer characteristics to test the influencing factors comprehensively. Second, this study only investigates the relationship between the geographical proximity of major customers and supplier tax avoidance from the perspective of information transfer and tax detection risk. Further study could combine the needs of the customer and the motivation of tax avoidance to explore the complex channels further. Third, we only focus on listed Chinese firms due to the data limitation. We suggest the need for further study to explore the relationship globally if the data allows.