The Hidden Cost of Corporate Tax Havens

Companies with tax haven headquarters are less likely to advance social causes, a new study proves

Walgreens is one of America’s most powerful brands. Founded in 1901, the midwestern pharmacy chain even claims to be the birthplace of an American classic, the malted milkshake. Today, over 9,000 Walgreens pharmacies fill over 1 billion prescriptions each month—and bring in nearly $130 billion in annual revenue.

But, in 2014, the company considered stashing these profits beyond the reach of the IRS. By acquiring Boots Alliance—a British pharmacy chain that is headquartered in Switzerland for tax purposes—Walgreens reached the threshold of 20 percent foreign ownership, qualifying the company to move its headquarters out of the United States.

By making Boots Alliance’s Swiss mailbox into its nominal headquarters, Walgreens would have saved approximately $4 billion in taxes in the first five years alone. Politicians were outraged; consumers threatened boycotts.

More than 300,000 Americans signed a petition demanding that Walgreens not “desert America.” Facing potential consumer backlash and political ramifications, the company decided to abandon its plan.

When taxes go, CSR does too

But if Walgreens had successfully moved its headquarters to Switzerland, tax revenue isn’t the only thing that Americans would have lost.

New research from McGill University’s Dongyoung Lee, an assistant professor of accounting, shows that when companies move their headquarters to lower-tax jurisdictions, they invest less in corporate social responsibility (CSR) activities.

This means that charities making improvements in health care, education, or the environment can expect to receive far fewer donations from companies that relocate their headquarters to a tax haven.

“There is an underlying assumption that when companies make use of a fiscal paradise, they are not doing much for the community. But that was an untested assumption. When I looked at the data, it showed that companies really did contribute less, despite having more tax savings,” says Lee.

There is also the prevailing belief that firms reincorporating in tax havens will engage in more CSR initiatives to rebuild their image or safeguard against further critique. But, according to the data, this is not actually happening—at least not in the United States.

“U.S. firms offer an interesting example since they are generally allowed to relocate their corporate tax residence without shifting their primary place of business—essentially by changing their mailing address,” Lee explains.

Lee examined 138 firm years of 46 U.S. corporations that had their headquarters in tax havens between 2004 and 2013. These companies were compared to a control sample of 211 firms that had their headquarters in the U.S. during the same time period. The study considered major firm characteristics such as size, cash holdings and industry, and measured their philanthropic giving.

Firms with their headquarters in a tax haven were shown to give significantly less to charity, and that being headquartered there was the main explanatory variable for the discrepancy.

More is more

Companies that evade taxes through fiscal paradises will rely on various justifications to avoid moral condemnation. A common argument in such cases is that lower corporate taxes will lead to increased charitable giving, which can enable the improved delivery of social services.

“In most cases, when a corporation engages in tax inversion, they say that they are doing it to create shareholder value. They want to increase the value of the stock, which will be good for the firm. That may be true, but the non-financial stakeholders can suffer,” states Lee.

Upending business as usual

Lee suspects that a business culture that places shareholder value above all else is largely to blame. For several decades, North American business schools have lionized the free-market thinking of economists like Milton Friedman. A generation of executives has been trained to pursue maximum profit at almost any cost.

In the aftermath of the 2008 financial crisis, the importance of training a new wave of business leaders that embodies a more socially and environmentally responsible approach to management has become paramount.

“The world is changing,” Lee says. “Business schools once taught students that when they become CEO, they work for shareholders—and that’s the way it is. But now we are teaching students that CEOs need to care about non-financial stakeholders, too.”

And within a corporation, change at the top is critical. The characteristics of CEOs and senior managers play an outsized role in setting the tone for a corporation’s overall culture.

“Research has shown that when top executives have prior legal infractions, their companies are more likely to commit fraud,” Lee explains.“Research has shown that when top executives have prior legal infractions, their companies are more likely to commit fraud,” Lee explains.

“So if they personally engage in tax avoidance, the firms that they oversee are more likely to avoid taxes. An organization’s culture is set by its leadership, and the top managers have a cascading effect on the whole organization. If the CEO says we only need to make money for the shareholders, then lower-level managers are going to think about how to make money for the shareholders, and not about the greater good,” he concludes.