This study examines whether outside directors’ equity-based compensation is associated with a firm’s tax avoidance. Using an instrumental variable approach that mitigates the endogeneity concern of director equity incentives, we find that firms paying a higher fraction of their outside director compensation in the form of equity have lower long-run effective tax rates. In addition, the positive effect of outside director equity incentives on tax avoidance is more pronounced in firms adopting a defender-type business strategy and in firms that are more financially constrained. Overall, the findings collectively suggest that equity-based compensation helps motivate outside directors to provide better advising and monitoring so that managers engage in more tax avoidance to maximize shareholder wealth.
tax avoidance, director compensation, outside director, equity-based incentive