Outside Director and Tax Avoidance: Focus on KOSDAQ Companies

We examine the association between the proportion of outside directors on the board and the extent of tax avoidance for KOSDAQ-listed firms. As the majority of KOSDAQ-listed firms are financially constrained, small and medium enterprises, it is highly likely that these firms will satisfy only the minimum legal requirements in assigning outside directors to the board. However, some firms exceed the minimum legal requirements (i.e., one-fourth of the total number of directors). As the proportion of outside directors increases, tax avoidance may decrease due to more effective monitoring of the CEO. Therefore, we expect the degree of tax avoidance to decreases as the proportion of outside directors increases. Moreover, we examine this relation to differ by management ownership. If the manager is also a major shareholder, as opposed to a hired professional CEO, they are more likely to avoid or restrict outside directors’ monitoring. From a sample of KOSDAQ-listed firms, this study finds that as the proportion of outside directors is negatively related to the degree of tax avoidance. This finding shows that the monitoring role of outside directors is influential with respect to tax avoidance behavior. However, the relation is weaker for firms where the management is also the owner. This suggests that owner-managers may restrict the monitoring activities of outside directors. This study has two contributions. First, this study shows that outside directors can decrease the agency cost between the managers and shareholders in terms of tax avoidance. Second, this study infers that the monitoring effect of outside directors can be influenced by the type of management.