Evidence of the invisible: toward a credibility revolution in the empirical analysis of tax evasion and the informal economy

Empirical research about tax evasion and the informal economy has exploded in the past few decades, seeking to shed light on the magnitude and (especially policy) determinants of these phenomena. Quantitative information informs the analysis of policy choices, enables the testing of hypotheses about determinants of this phenomenon, and can help with the accurate construction of national income accounts. Even as empirical analysis has burgeoned, some have expressed doubts about the quality and usefulness of some prominent measures. The fact that high-quality data is elusive is neither surprising nor a coincidence. The defining characteristic of tax evasion and informal economic activity—that they are generally illegal—often renders unreliable standard data collection methods such as surveys. Unlike invisible phenomena in the natural sciences, these invisible social science phenomena are hard to measure because of choices made by individuals. Analysis of tax evasion and the informal economy must proceed even in the absence of the direct observability of key variables, and theory should guide the construction and interpretation of evidence of the “invisible.” In this paper, we address what can be learned using micro or macro data regarding tax evasion and the informal economy under given conditions and assumptions, and critically review some of the most common empirical methods in light of our conclusions. We conclude with an entreaty for researchers in this field to enlist in the “credibility revolution” (Angrist and Pischke in J. Econ. Perspect. 4(2):3–30, 2010) in applied econometrics.     

It's so hard to be fair

When employees believe they are being treated fairly-when they feel heard, when they understand how and why important decisions are made, and when they believe they are respected-their companies will benefit. Research shows that practicing process fairness reduces legal costs from wrongful-termination suits, lowers employee turnover, helps generate support for new strategic initiatives, and fosters a culture that promotes innovation. What's more, it costs little financially to implement Yet few companies practice it consistently. Joel Brockner examines this paradox, exploring psychological and other reasons that cause managers to resist embracing process fairness. The fact that it's relatively inexpensive to implement, for instance, may be why some numbers-oriented executives undervalue it. Many managers believe that they practice process fairness, but 360-degree feedback tells another story. Some corporate policies actually undermine it--such as when the legal department won't let managers fully explain decisions for fear that disclosure could expose the firm to lawsuits. And, frequently, managers simply follow the all-too-human tendency to avoid uncomfortable situations. But the good news is that organizations can take concrete steps to promote greater process fairness. Many studies have shown that training programs make a big difference, and the author describes the most effective format. In addition, warning your managers that they may experience negative emotions when practicing fair process will help prepare them to cope with those feelings. Finally, role modeling fair process on the executive level will help spread the practice throughout the organization. The fact is, process fairness is the responsibility of all executives, at all levels and in all functions; it cannot be delegated to HR. The sooner managers realize that and work to make it a company norm, the better off the organization will be.     

Bootstrapping the Box–Pierce Q test: A robust test of uncorrelatedness

This paper describes a test of the null hypothesis that the first K autocorrelations of a covariance stationary time series are zero in the presence of statistical dependence. The test is based on the Box–Pierce Q statistic with bootstrap-based P-values. The bootstrap is implemented using a double blocks-of-blocks procedure with prewhitening. The finite sample performance of the bootstrap Q   test is investigated by simulation. In our experiments, the performance is satisfactory for samples of n=500$n=500$. At this sample size, the differences between the empirical and nominal rejection probabilities are essentially eliminated.     

The Revenue Consequences of Using Formula Apportionment to Calculate U.S. and Foreign-Source Income: A Firm-Level Analysis

This paper examines the 1989–1993 publicly available financial reports of 46 U.S.-based multinationals to estimate the revenue implications of implementing a U.S. federal formula apportionment system. Ignoring behavioral responses, we estimate shifting to an equal-weighted, three-factor formula would have increased their U.S. tax liabilities by 38 percent, with an 81 percent increase for oil and gas firms. We find the firms report a lower percentage of their worldwide profits as American profits than their American share of assets, sales, or payroll. The results may be attributed to more profitable foreign operations, tax-motivated income shifting, or measurement error.     

The financialization of the non‐financial corporation. A critique to the financial turn of accumulation hypothesis

One aspect in which non‐financial corporations (NFCs) are said to be financialized is that they have been increasingly engaged in financial accumulation from which they derive a growing proportion of financial income. This is what we call the financial turn of accumulation hypothesis. In this article, we show that the evidence used to sustain it, in the U.S. setting, has to be reconsidered. Our findings show that, contrary to the financial turn of accumulation hypothesis, financial income averages 2.5% of NFCs’ total income since the 1980s, oscillating since the beginnings of the 1990s until 2005 and then declining. In terms of assets, some of the alleged financial assets might actually reflect other activities in which NFCs have been increasingly engaged, such as tax avoidance, internationalization of production, activities refocusing and M&As.     

A Look Back at Modern Finance: Accomplishments and Limitations

In a conversation held in June 2016 between Nobel laureate Eugene Fama of the University of Chicago and Joel Stern, chairman and CEO of Stern Value Management, Professor Fama revisited some of the landmarks of “modern finance,” a movement that was launched in the early 1960s at Chicago and other leading business schools, and that gave rise to Efficient Markets Theory, the Modigliani‐Miller “irrelevance” propositions, and the Capital Asset Pricing Model. These concepts and models are still taught at prestigious business schools, whose graduates continue to make use of them in corporations and investment firms throughout the world. But while acknowledging the staying power of “modern finance,” Fama also notes that, even after a half‐century of research and refinements, most asset‐pricing models have failed empirically. Estimating something as apparently simple as the cost of capital remains fraught with difficulty. He dismisses betas for individual stocks as “garbage,” and even industry betas are said to be unstable, “too dynamic through time.” What's more, the wide range of estimates for the market risk premium—anywhere from 2% to 10%—casts doubt on their reliability and practical usefulness. And as if to reaffirm the fundamental insight of the M&M “irrelevance” propositions—namely, that what companies do with the right‐hand sides of their balance sheets “doesn't matter”—Fama observes that “we still have no real resolution on the key questions of debt and taxes, or dividends and taxes.” But if he has reservations about much of modern finance, Professor Fama is even more skeptical about subfields now in vogue such as behavioral finance, which he describes as “mostly just dredging for anomalies,” with no underlying theory and no testable predictions. Although he does not dispute that a number of well‐documented traits from cognitive psychology show up in individual behavior, Fama says that behavioral economists have thus far failed to come up with a testable theory that links cognitive psychology to market prices. And he continues to defend the concept of “efficient markets” with which his name has long been closely associated, while noting that empirically based asset pricing models such as his (with Ken French) “three‐factor” CAPM have produced much better results than the standard CAPM.     

Optimal capital structures for private firms

This article shows how to construct an optimal capital structure for a private firm. Since the agents who supply the firm’s capital are risk averse, they diversify by holding both debt and equity. This can mitigate, or even eliminate, the classical risk shifting problem. There is a wealth effect since the optimal capital structure, which can involve multiple types of debt, depends on the amount of wealth that each agent contributes to the firm. However, it is shown that the agents’ equity holdings do not depend on the contributed amounts of wealth. Thus the model can produce a wedge between ownership rights and equity cashflow rights. These features are illustrated in a firm with three agents.     

Reexamining the uncertain information hypothesis on the S&P 500 Index and SPDRs

This paper examines the uncertain information hypothesis on one major index and its corresponding exchange-traded fund: the S&P 500 Index and SPDRs in the pre-SPDRs (01/63–12/93) and post-SPDRs (01/94–12/03) periods. Two strategies are used to measure the economic significance of the uncertain information hypothesis. Overall, we present evidence confirming the uncertain information hypothesis in the post-SPDRs period. However, we fail to convert the statistically significant gains observed into economic gains under a conservative approach. In addition, the degree of difference in the volatilities of the 5-day post-event returns (in both the S&P 500 and the SPDR) among the three subgroups diminishes in the post-SPDR period. Hence, we conclude that the market is in fact short-term efficient in a more realistic setting.     

Are there Language Markers of Hubris in CEO Letters to Shareholders?

This paper explores whether DICTION text analysis software reveals distinctive language markers of a verbal tone of hubris in annual letters to shareholders signed by CEOs of major companies. We analyze 193 letters to shareholders, comprising about 368,000 words, focusing initially on 23 letters signed by CEOs who are alleged to be hubristic: Browne (BP), Goodwin (Royal Bank of Scotland), and Murdoch (News). Their language use is statistically significantly high in terms of the DICTION master variable, REALISM. Based on further analysis, we contend that language high in REALISM is not a distinctive marker of hubris but is likely to be a genre effect that is common in CEO letters to shareholders. We draw attention to the restricted capacity of DICTION to capture subtlety of language in CEO letters to shareholders.