The presence of an outside director on the company board can act as a dampener to the tax aggressive behaviour of private family firms with low CEO ownership shares. Thus concludes a recent SSRN paper by Tensie Steijvers of Hasselt University, Belgium, and Mervi Niskanen of University of Eastern Finland. ‘Tax aggressiveness,' for starters, is defined as downward management of taxable income through tax planning activities which can be legal or illegal or may lie in between (Frank et al., 2009).

Interestingly, there have been studies showing that private family firms are particularly suitable to study tax aggressiveness; and that since private ownership lacks disciplining of the market for corporate control, agency costs could be high (Schulze et al., 2001). It can be frightening to know that ‘agency costs' may include ‘rent extraction' by CEO vis-à-vis the other shareholders, by masking earnings management, perquisite consumption, and excessive salaries. (Economic ‘rent' refers to excess returns above normal levels that take place in competitive markets, unlike contract rent which is mutually agreed upon between the land-owner and the user.)

It is not as if the CEO is not incurring any costs. For, on his cost side, he has to take into account the time that has to be invested to implement the tax evasion measures, the possible penalty from tax authorities and the possible damage to the firm's reputation and family's socio-emotional wealth, the paper points out.

Reputation concerns

The authors make a reference to research findings that private family firms have a much longer investment horizon and greater reputation concerns (Gedajlovic and Carney, 2010); and that family firms do not only have financial goals but also non-economic goals such as preservation of the family dynasty and perpetuation of family values through the business, that meet the family's affective needs which is described as socio-emotional wealth (Gomez-Mejia et al., 2007).

Instructively, previous studies indicate that the CEO turnover is significantly lower in family firms, indicating that possible rent extraction is less likely to be punished by the shareholders (Tsai et al., 2006). And, as the paper cautions, since private family firm owners are under-diversified, and have their wealth tied disproportionately to their firms, any penalty for the tax authorities is more likely to be substantial to them.

Important read for family businesses.

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