“The impact of labor unions on corporate tax avoidance: evidence from Korea”

This study examines the effect of labor unions on corporate tax avoidance activities. Labor union is an important stakeholder in terms of corporate governance; thus, managers may engage in certain accounting choices that reflect union members’ position to improve the relation with labor union. This paper empirically investigates whether managers engage in tax avoidance activities to secure financial resources for workers’ pay when the negotiation power of labor unions is higher. The empirical analysis is based on a sample of firms listed in the Korean stock market from 2001 to 2008. The authors find that companies, where labor unions are organized, have a significantly higher level of tax avoidance activities. Also, the authors attempt to examine the effect of labor unions’ bargaining power on tax avoidance. While the union membership ratio is not significantly related to tax avoidance, labor unions that belong to upper-level labor organizations significantly affect the increasing tax avoidance activity, on average. Moreover, companies that join an aggressive labor organization (‘Minju’ Federation) show a significantly higher level of tax avoidance activity, compared to those joining a moderate labor organization (‘Hanguk’ Federation). Furthermore, the authors show that such an effect of labor unions on tax avoidance is significant for companies, which are not affiliated with large business groups (‘chaebols’). This result suggests that chae-bol group management is not under pressure to negotiate with union members due to higher reputation costs. The findings of this paper offer academic and practical implications that capital market participants need to understand labor unions’ effect on management’s accounting choices.


INTRODUCTION
The main purpose of accounting is to provide useful information for accounting information users' decision making.Accounting information users include a company's stakeholders who are individuals or organizations that are related to a firm's business activities or their outcomes, such as shareholders, creditors, customers, and workers.This study is focused on workers as a company's internal stakeholder and accounting information users in labor-management negotiation.The authors examine the effect of labor unions, specifically the workers' negotiation power, on corporate tax avoidance activities.
Corporate tax avoidance activities are classified into lawful tax reduction to reduce tax burden using the incompleteness of the tax law and tax evasion, which reduces tax cost by violating the tax law.Lawful tax avoidance within a legal boundary is a crucial strategic business activity to reduce the tax burden.Such tax avoidance activities are shown to be related to opportunistic managerial be-havior and lower reliability of accounting information.Thus, government regulations and corporate monitoring have been documented to reduce the level of tax avoidance activities (Desai & Dharmapala, 2005;Wilson, 2009).
The primary purpose of labor unions is to secure or maximize the wage of labor union members.The authors posit that as a labor union's negotiation power increases, managers will be more likely to engage in tax avoidance activities to secure financial resources for workers' pay.The empirical analysis results can be summarized as follows.The association between the firms' unionization and tax avoidance is positive and marginally significant, while the union membership ratio does not significantly affect corporate tax avoidance.Moreover, firms whose labor unions belong to an upper-level labor organization are found to increase their tax avoidance activities, on average.Specifically, companies joining a belligerent upper-level labor organization have significantly higher tax avoidance level than those which joined a moderate upper-level labor organization.These results indicate that managers tend to increase the level of tax avoidance activities to procure financial resources to compensate for workers when the labor unions have higher negotiation power by joining the upper-level labor organizations.Further, additional tests show that the association between labor union and tax avoidance is not significant for firms that are affiliated with large business groups ('chaebols') due to higher reputation costs.
This study makes several contributions to the literature.First, prior studies have focused on firm characteristics and/or corporate governance variables as the factors affecting firms' tax avoidance.Meanwhile, this study provides an important differentiated implication that labor union, key stakeholders of corporations, can affect tax avoidance activities.Second, the research setting based on Korean capital market adds fresh evidence to a stream of research on the relationship between labor union and corporate tax avoidance.Prior research based on U.S. data has relied on industry-level unionization data due to the lack of data availability on firm-level unionization (e.g., Klasa, Maxwell, & Ortiz-Molina, 2009; Chen, Kacperczyk, & Ortiz-Molina, 2011).Also, since not all firms disclose their labor-related expenditures, inaccurate sampling may result in a self-selection bias.However, in Korea, companies were required to disclose labor union-related data until 2008.Thus, firm-level unionization data is available for comprehensive coverage of firms in Korea, allowing a more accurate estimation of the relation between labor union and corporate tax avoidance.
The remainder of this paper consists of the following.Section 1 introduces the related literature and sets the research hypotheses.Section 2 describes the sample selection, research model, and empirical methodologies.Section 3 reports the results of empirical analyses, and final section presents the conclusion and its implications.(Matsa, 2010), firm performance (Bova, 2013), cost of equity and debt capital (Chen, Kacperczyk, & Ortiz-Molina, 2011).

LITERATURE REVIEW AND DEVELOPMENT OF HYPOTHESES
Labor unions require management to share information for salary negotiation, although management are inclined to withhold private information (Hilary, 2006;Kleiner & Bouillon, 1988).Since access to essential corporate information could increase the union's bargaining power, managers are more apt to win negotiations with an unapprised workforce by rendering crucial data inaccessible to employees (Croson, 2005).Also, Scott (1994) discovered that Canadian companies, which were prone to strikes, were more likely to downplay detailed information on pension.Moreover, labor union's clamor for salary hikes became more fervent when the labor union showed resilience (Klasa, Maxwell, & Ortiz-Molina, 2009; Matsa 2010).In fact, as the union's strength increases, the curtailment of information rises (Hilary, 2006).
Labor unions are considered rent-seekers who are motivated to obtain as much quasi-rent as they can through negotiation or strike intimidation (Grout, 1984

Tax avoidance
Companies create profits through operating activities during the fiscal period, and they have a certain ratio of the created profits to pay to the government as corporate income tax cost.Companies attempt to increase net profit by deducting taxes to pay from gross profits.Concerning this, Dyreng, Hanlon, and Maydew (2008) defined tax avoid-1 Tax avoidance is an activity to reduce the tax burden in a method that law does not intend within tax law regulations using the incompleteness of tax laws.Tax evasion is an act to reduce the tax burden in an illegal method, including deliberate distortion of fact; for example, a virtual expenditure stating expenditure that was incurred despite the absence of any real transaction, and over-estimation of expenditure.Tax evasion activity is an act reducing national finances, and other people should pay more tax for tax revenue reduction by tax evasion activity, or a measure to increase the tax rate can be presented.If tax evasion is detected, tax default, and additional tax can be levied and criminal penalty can be imposed.Tax planning is an activity to reduce taxes in a lawful and rational method within a tax law-acknowledged scope, with tax credit or the reduction and exemption of taxes being good examples.Tax avoidance, in a broad sense, can include lawful tax reduction and illegal tax evasion.Tax avoidance, in a narrow sense, can be defined as a tax burden reduction activity, except illegal tax evasion.This study defines tax avoidance activity in a narrow sense.
ance as an ability to reduce cash corporate income tax related to profits before taxes. 1   Because tax cost is an item accompanying cash outflows, reduced tax cost implies a decline in cash outflows.As a firm's cash holdings increase, net profit increases, and the firm can better respond to risks, thereby having a positive effect on firm value.However, if increased cash generated from tax avoidance is not used for stockholders' wealth maximization, thee accompanied cost may be incurred.Due to information asymmetry between the manager and stockholders, a conflict between the stockholders and the manager can become severe.In other words, if the cost related to tax avoidance is greater than the benefit, the negative function of tax avoidance may be exposed.
According to prior studies, corporate governance affects the cost and benefit generated by tax avoidance (Desai, Foley, & Hines, 2004;Desai & Dharmapala, 2006).According to agency theory, because a firm's ownership and management are separated, managers may have incentives to take their private benefits, which can be accelerated with information asymmetry between stockholders and managers (Fama, 1980;Fama & Jensen, 1983).Also, they documented a significantly negative relationship between foreigners' equity ratio and tax avoidance.
While many studies have focused on firm-level characteristics affecting tax avoidance, there is sparse evidence on the role of labor union, another key stakeholder of a company, in tax avoidance.
Hence, this study is differentiated from prior studies by identifying the effect of a labor union's negotiation power on tax avoidance.

Hypotheses development
Interest in the status of a company having a labor union, namely the classification of companies having labor unions and those without labor unions, is a study field that has been dealt with heavily in the theory of labor relations.The reason is that studies on the determinants of joining labor unions empirically show the differences between companies having labor unions and those without labor unions.
The primary goal of the labor union is to maximize union members' compensation; thus, managers of the companies having labor unions are likely to experience pressure on wage raise, com-pared to the companies not having labor unions.
In a situation where labor unions, claimants of residual income, exist, more incentives for managers to procure financial resources exist through managers' tax avoidance activity.According to inference on prior studies, managers in the case of labor union existence are predicted to enhance incentives to procure financial resources through tax avoidance activity, which is an opportunistic purpose to respond to a labor union's demand for wage raise, and thus hypotheses are set as follows: H1: There is a positive association between unionization and tax avoidance activities.
A labor union's negotiation power can be measured in two ways.First, a labor union's negotiation power can be measured with union ratio according to prior studies.Union ratio is the value in which the number of labor union members is divided by the total number of employees (Clark, 1984 In other words, it is based on a hypothesis that a labor union's negotiation power is consolidated as a labor union's union ratio becomes higher.
Another value to measure in relation to a labor union's negotiation power is whether a company has joined an upper-level labor organization.In case a company's labor union has joined an upper-level labor organization, the labor union's negotiation power can be higher than that of the companies where labor unions have not joined an upper-level labor organization because an upper-level labor organization supports its member company's collective bargaining process, and there is a possibility to hugely contribute to the maximization of a member company's labor union member's compensation through strikes using the organization's member companies.
In a real-life scenario, the status of joining an upper-level labor organization can show the company's negotiation power compared to union ratio.Also, the company's manager tries to cope with the upper-level labor organization's strikes by paying more attention to whether its labor union has joined an upper-level labor organization.As a labor union's negotiation power strengthens, manhttp://dx.doi.org/10.21511/ppm.18(2).2020.11 agers will be more interested in procuring financial resources for workers' compensation.Since the status of joining an upper-level labor organization can show a company's negotiation power, those companies whose labor unions joined the upper-level labor organization will receive direct wage raise pressure compared to the companies whose union rate at the individual company level is high.Therefore, in situations where the labor union, a claimant of the residual income, exists, the incentives for managers to procure financial resources through tax avoidance becomes bigger.
As such, the membership to upper level labor organizations is forecast to increase the incentives to procure financial resources through tax avoidance, compared to union ratio; thus, the following hypothesis is set.
H2: The status of membership to an upper-level labor organization will have a bigger effect on a firm's tax avoidance, compared to union ratio.

Measures related to labor unions
As for the data on the current status of companies' labor unions, they are an item to be disclosed for business reports, and the information included in the current status of labor unions can be: member, number of members, number of full-time workers, and affiliated federation.Whether companies have labor unions or not, union ratio measurement by the company is possible.This study collected data on the number of union members to identify the status of labor unions and union ratio according to the study's purpose.
The variables used to measure the effect of labor unions are as follows: First, the status of having a labor union (UNION) is a dummy variable having 1 point if the union member is 1 or more, or 0 otherwise.Second, the intensity of labor unions was measured by union ratio according to prior studies.Union ratio is the value calculated by dividing the number of labor union members by the total number of employees (Clark, 1984 Because the data on labor union by the company can be acquired from the business report in Korea, an econometric control method can be adopted in consideration of an endogeneity problem.There is an advantage that hypothesis verification is possible based on more sophisticated analysis in that it is free from the measurable error problem that occurs when industry-level data are used.

Measures of tax avoidance
It is difficult to measure tax avoidance activity because a firm's tax return data are not disclosed.Therefore, studies to address such a problem continue to be carried out ( Subsequently, the difference between the profit from financial report (net profit before corporate income tax) and estimated profit from tax report is calculated.The companies whose profit from tax report is calculated as 0 or negative (-) in value has small incentives to conduct tax avoidance; thus, this study measures tax avoidance activity by being composed only of the companies with more than 0 profit from tax reports.
As stated above, because a firm's tax avoidance activity is included in the part where the difference between the profit from financial report and profit from tax report cannot be explained with profit-adjusting activity, the tax avoidance measured value can be calculated only if the part generated by profit adjustment for financial report purpose in the BTD generation factors is removed.Desai and Dharmapala (2006) measure a manager's profit-adjusting activity level using total accruals.As an alternative value of profit-adjusting activity, this study reported no difference in the result, although discretionary accruals are used.
By referring to the above, this study conducts a regression analysis by year and by industry using the following equation, Equation (1), by using discretionary accruals that can be viewed as more accurate than the alternative value of profit adjustment.This study then views the drawn residual as TA1 and the total accruals as an alternative value of profit adjustment, carrying out a regression analysis by year and by industry using the Equation (1) model and defining the drawn residual as TA2.

Model specifications
The following model ( 2 (2006), a firm's profit adjustment affects the total assets change rate and total debt change rate, as well as asset and debt sizes.The relationship between total asset change rate and tax avoidance can differ according to political cost theory or political power theory hypotheses equivalent to asset size.Although firms, whose debts increased, showed lower tax avoidance level due to the reduction of profit from the tax report due to a debt's tax reduction effect, the firms whose debts fell could not use a debt's tax reduction effect, and thus they tried to reduce profit from tax report by increasing tax avoidance level.Therefore, debt change rate presents a possibility of creating a negative relationship with tax avoidance.As a proportion of ownership held by foreign investors (FOR) is higher, tax avoidance activity monitoring consolidation is likely to be higher, and thus the FOR variable was added as a control variable (Park, Lee, & Hong, 2009).As the proportion of ownership held by the largest shareholder (BIG) gets higher, the firm will prefer cash secured through tax avoidance; thus, the variable BIG was added as a control variable.Lastly, the industry dummy (IND) and year dummy (YD) variables were included in the model to control the differences by year and by industry under tax law regulations (Kim & Jeong, 2006).We also adjusted standard error for firm clusters (Petersen, 2009).

Sample selection procedure
The analysis subject of this study was the firms listed in the Korean stock market from 2001 to 2008.The financial statement and stock price data used in this study were extracted from the KIS-VALUE database.Firms belonging to financial industries and those with non-December year-end were excluded from the sample due to difficulty in comparing financial statements.Also, companies with impaired capital were excluded from the study since these observations may distort the forecast.After we removed observations with insufficient financial data, the final sample consisted of 3,605 firm-year observations.Also, Table 1 reports the Pearson correlation coefficients among test variables.Correlations analysis suggests that unionized firms are likely to have larger total assets, higher liabilities to assets ratio, greater investments, higher ownership of foreign investors, and largest shareholders.

H1: Unionization and tax avoidance
Table 2 provides the regression test results of H1, which examines the association between firms' unionization and tax avoidance level.
In Panel A, the dependent variable is TA1, which is the tax avoidance measure using total accruals as the proxy of earnings manipulation.The regression coefficient of UNION is 0.0045 (p-value = 0.0866), positive and significant at 10% level.Panel B, in which the dependent variable is TA2 using discretionary accruals to proxy earnings manipulation, shows that the key variable UNION has a positive coefficient of 0.0041, with p-value = 0.1090.These results indicate that unionized firms tend to have greater corporate tax avoidance activity.
Regarding control variables, corporate tax avoidance is positively associated with firm size, lev-ROA, cash holdings, and assets growth.However, investments, prior-year discretionary accruals, liabilities growth, and foreign investors' ownership are negatively related to tax avoidance.

H3: Union alliance and tax avoidance
Table 4 shows the test results of whether the federation of Korean Trade of Union affects the level of corporate tax avoidance.
In both panels, the regression coefficients of UNION_MINJU are positive and statistically significant at 1% level (0.0105, p-value < 0.01; 0.0104, p-value < 0.01).On the other hand, the coefficients of UNION_HANGUK are not significant (0.0026, p-value = 0.42; 0.0025, p-value = 0.43).This means that companies, which joined aggressive labor organization (Minju), have greater pressure from their labor unions so that they have a greater level of tax avoidance activities.In contrast, the firm's affiliation with moderate labor organization (Hanguk) does not have any significant impact on the management.These results are consistent with the prediction for H3.

Additional tests: chaebols vs. non-chaebols
The authors perform additional tests to address the impact of firms' affiliation with major Korean business groups (i.e., chaebols) on the relationship between labor union and tax avoidance.For this, they estimate the regression model used in the main tests using two sub-samples: chaebol firms versus non-chaebol firms.
As a result, the authors find that the main results do not hold for chaebol firms, suggesting that labor unions in chaebol-affiliated firms do not significantly affect corporate tax avoidance activity.On the contrary, the effect of labor unions on tax avoidance is still significant for non-chaebol firms.
These results indicate that due to certain chaebol firms' ownership structure, the negotiation of labor unions does not pressure management to engage in tax avoidance activity to secure wages for union members.

DISCUSSION
The authors discuss the important contributions of the study in this section.First, this is the first study that verified the effects of labor unions, a firm's key stakeholder, on a firm's tax avoidance activity.Prior studies mainly paid attention to firm characteristics and corporate governance, namely shareholders and creditors, as the factors affecting the firms' tax avoidance.This study presented various implications on how labor unions affect corporate tax avoidance activity.
Second, this study improved the research setting to examine the relation between labor unions and tax avoidance activities.The authors avoided the self-selection bias by exploiting a Korean setting where the disclosure of labor costs is mandatory for all publicly traded firms.Since firm-level unionization data is available for comprehensive coverage of firms, it was possible to accurately es-timate the relation between labor unions and tax avoidance activities.
Moreover, this study contributed to the literature by examining the effects of labor unions' affiliations with an upper-level labor organization, which could measure the negotiation power of labor union, on tax avoidance.This is unique to the existing literature using Korean data.This study is important in that it has additionally verified the effects of the status of a labor union's membership to an upper level labor organization, which can serve as the alternative proxy of a labor union's negotiation power that can be checked through Korean data.
However, a measurement error problem still exists when measuring tax avoidance activity level and a labor union's effects.Follow-up studies addressing such a problem are expected to be carried out.

CONCLUSION
This study analyzed the effects of labor unions on a manager's tax avoidance activities.Specifically, unionization, union ratio, the status of joining an upper level labor organization, and the status of joining a belligerent upper level labor organization were measured while the effects of labor unions on a manager's tax avoidance activity were analyzed.
The analysis results of this study can be summarized as follows.As a result of an empirical analysis on the disclosed data of Korea's unique labor unions, namely mandatory disclosure of labor union-related data until 2008, the status of a labor union's existence did not affect a company's tax avoidance activity.However, when it comes to an analysis of the companies that have organized labor unions, the union ratio widely used as the alternative value of a labor union's effect in prior studies did not have a statistically significant effect on a company's tax avoidance activity.However, the status of a labor union's joining an upper level labor organization had an effect in increasing a company's tax avoidance activity on average.Companies whose labor unions joined a belligerent upper level labor organization especially showed statistically and significantly higher tax avoidance activities, compared to those that joined a moderate upper level labor organization.As a result of additional analysis, the labor union's effects on a company's tax avoidance activities were found to be consolidated in non-conglomerate groups compared to conglomerate groups.

Table 1 .
Descriptive statistics and correlations

Table 2 .
Unionization and tax avoidance activities

Table 3 .
The bargaining power of labor union and tax avoidance activities

Table 4 .
The membership of the Federation of Korean Trade of Union and tax avoidance activities; Minju vs. Hanguk

Table 5 .
Sensitivity test: labor union and tax avoidance activities for chaebol vs. non-chaebol firms