Political connections, joint audit and tax avoidance: evidence from Islamic banking industry
| DOI | https://doi.org/10.1108/JFC-01-2019-0015 |
| Pages | 155-171 |
| Date | 22 January 2020 |
| Published date | 22 January 2020 |
| Author | Hana Ajili,Hichem Khlif |
| Subject Matter | Financial risk/company failure,Accounting & Finance |
Political connections, joint audit
and tax avoidance: evidence from
Islamic banking industry
Hana Ajili
Department of Accounting, Faculty of Economics and Management,
Laboratory GFC Sfax, University of Sfax, Sfax, Tunisia, and
Hichem Khlif
Department of Accounting, Faculty of Economics and Management,
Laboratory GFC Sfax, University of Sfax, Kerkennah, Tunisia
Abstract
Purpose –The purpose of this paper is to examine the association between political connections and tax
avoidancein Islamic banking industry and to test whether joint audit affects thisrelationship.
Design/methodology/approach –Tax avoidance is measured using effective tax rate while political
connections represent an indicator variable that equals 1 if a bank has at least one politically connected
directoron the board of directors and zero otherwise.
Findings –This study documents that political connections are negatively associated with effective tax
rate, while joint audit is positively related to the same variable. We also find that the negative association
between political connections and effective tax rate becomes insignificant for joint-audited banks, while it
remains negativeand significant for banks audited by one auditors.
Originality/value –The findingsof this study have policy implications forbanking industry because joint
audit reducesthe adverse effect of political connections on tax avoidance.
Keywords Tax avoidance, Political connections, Joint audit, Islamic banking industry
Paper type Research paper
1. Introduction
The stream of empirical researchdealing with the association between political connections
and tax avoidance has attracted considerable attention among accounting scholars (Abdul
Wahab et al.,2017;Adhikari et al.,2006;Kimand Zhang, 2016). The findings of these studies
are supportive of a positive (negative) association between political ties and tax avoidance
(effective tax rate). All these studies have removed financial companies from their analysis
given the specificity of banking industry in terms of regulation. Accordingly, it becomes
interesting to explore such an association in banking industry (Islamic banking) to test
whether political connections have the same influence on tax avoidance in this sector.
Furthermore, we examinewhether joint audit, as a proxy for audit quality, moderates such a
relationship because there is a general wisdom that joint audit improves auditor
independence as it is more expensive for a company to “bribe”two auditors in joint audit
than one auditor in single audit (Deng et al.,2014).
Accordingly, this study tries to complement the above streams of research by exploring
the direct effect of political connections on tax avoidance in Islamic banking industry and
tests whether joint audit affects this association. The choice of Islamic banking industry is
mainly justified by the fact that main Islamic banks have been established in a country
Evidence from
Islamic
banking
industry
155
Journalof Financial Crime
Vol.27 No. 1, 2020
pp. 155-171
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-01-2019-0015
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
characterised by high levels of political involvement in business world and a relationship-
based economy (e.g. Malaysia, Indonesia and Gulf Cooperation Council (GCC) countries)
(Abdul Wahab et al.,2017;Al-Hadi et al.,2017;Adhikari et al., 2006).
Tax avoidance (effective tax rate) is definedas total income tax expense divided by pre-
tax book income, while politicalconnections is a dummy variable indicating whether a bank
is politically connected. Based on a sample of 18 listed Islamic banks over the 2007-16
period, we find that banks with political connectionspay tax at significantly lower effective
rates. These results suggest that political connections are an important determinant of tax
avoidance in banking industry. Furthermore, the negative association between political
connections and effective tax rate becomes insignificant for joint audited banks, while it
remains negative and significantfor banks audited by a single auditor.
Our research makes the following contributions. First, very little is currently known
about the association between political connections and tax avoidance in banking sector.
Second, we complement previous literature on joint audit because joint audit provides a
unique setting for analyzing both audit evidence precision and auditor independence
(Deng et al., 2014). Although the existing empirical research focuses on the impact of joint
audit on audit quality and audit fees (Gonthier-Besacier and Schatt, 2007;Ratzinger-Sakel
et al.,2013;Thinggaard and Kiertzner, 2008), our paper provides new empirical evidenceon
the moderating impact of joint audit on the relationship between political connections and
tax avoidance. Finally, this study should be of interest to tax policymakers and regulators.
Our findings suggest that banks employing politically connected directors exhibit higher
tax avoidance; however, this relationship is weakened with joint audit. Accordingly,
government should strengthenjoint audit, as an external control mechanism, in the banking
sector to reduce the adverse effect of politicalconnections on tax avoidance.
The remainder of the paper is structured as follows. Section II presents a review of the
literature and develops hypotheses. Section III outlines the research design and methods.
Section IV discusses the main results. Section V presents the results of additional analyses
and robustness checks.Finally, Section VI provides the conclusion for this study.
2. Research hypotheses
2.1 Political connections and tax avoidance
Managers may have several incentives to enter into politics to be less burdened with
regulations and less exposed to monitoring and oversight (Habib et al., 2017). This is
particularly true within the banking industry, generally considered as highly regulated
sector. Accordingly, the managers of politically connected banks may benefit from their
connections to reduce their tax payments because they will be protected against detection
and future litigationrisks and will have private access to preferential information.
The first benefit of corporate political connections is to be protected by politicians
against detection and future litigation risks. Christensen et al. (2015) focus on the
association between tax avoidance and risk. They indicate that, in the case that
reducing taxes can help a firm to keep more of its profits, managers would want to
minimize taxes without exposing firm to any types of risks and uncertainties that tax
avoidance exposes the firm to. Accordingly, Li et al. (2016) document that once the tax
earnings management is discovered, the firm faces severe punishment from both the
securities regulatory committee and tax authority, which may dramatically damage the
firm’s value. Hence, tax avoidance would be optimal only for firms with the ability to
lower their tax burden and avoid punishment, primarily firms with politically
connected management (Li et al., 2016). Furthermore, politically connected firms have
less market pressure to be transparent (Kim and Zhang, 2016). Indeed, tax avoidance
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