"The tax shelter war is over. The government won."
So began the remarks of Pam Olson, a Skadden partner who formerly worked at Treasury as Assistant Secretary for Tax Policy, at yesterday's conference on "The Future of Tax Shelters." Ms. Olson attributed the victory to, among several other factors, the impact of Sarbanes-Oxley. Companies are too busy dealing with section 404 auditors to have time for tax shelters.
Later in the day, I presented my Essay on Options Backdating, Tax Shelters, and Corporate Culture. In the Essay, I suggest that process-oriented solutions (like SOX section 404) can be effective in creating a culture of compliance. Perhaps too effective. Some of the evidence from backdating suggests that there may be a trade-off between creativity and product innovation on the one hand, and compliance on the other.
In the Q&A, Brett McDonnell asked me an interesting question about the extent to which we should use internal financial controls to serve goals other than creating shareholder value. I wasn't sure how to answer that. Tax compliance is good for the public. But it may not be so good for shareholders, who would prefer that corporations keep the money rather than pay it to the government. Or maybe it is good for shareholders; tax avoidance is associated with earnings management, which is usually bad for shareholders. (See here.) How do we determine the optimal level of tax compliance?
Brett pointed me to this paper by Larry Cunningham, which discusses using internal controls to serve goals like national security. Along somewhat similar lines, Don Langevoort describes how SOX is pushing outside directors to act as representatives of the public interest and not just protectors of shareholder value.
I'm finding this a fascinating question in part because it forces us to question the extent to which we think of corporations as social/public institutions (if at all). If you think corporations are purely private institutions, just efficient contractual devices for aggregating capital, then you'll tend to resist using internal controls or outside directors to serve any interest other than increasing shareholder value. If, however, you think that corporations are also important public institutions, you may be more willing to impose public-oriented duties on directors, officers, and auditors. Compliance with the law has always been an expected part of the duties of fiduciaries like directors and officers. But should we also ask them to be on the lookout for fraud beyond what the normal shareholder cost-benefit analysis would suggest? If so, how much do we want them to detect? How much of the government's tax enforcement duties can be outsourced to outside directors and auditors?
My knowledge of the tax literature is deeper than my knowledge of the corporate governance literature. Any suggestions for further reading?
Thank you to Kristin Hickman, Claire Hill, and to the University of Minnesota for a great conference.
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