Overinvesting activities and tax avoidance: The case of South Korea

Sound investment is a prerequisite for an enterprise to maintain sustainable growth. Any sluggish investment of capital may weaken growth potential, which ultimately leads to weakened economic foundation. Any overinvestment beyond the optimal level can result not only in pressure on cash flow but also on economic cost thatmay check its growth. Overinvestment that is not supported by any appropriate investment earnings rate causes enterprises to suffer opportunity cost and fund-shortage, which will weaken their growth and give rise to the vicious cycle from underinvestment. This study investigates whether thebehavior of overinvestment affects tax avoidance. Many previousstudies reportedthat overinvestingis related to opportunistic behavior of managers. This study implements OLS regression of overinvestment variables by McNichols and Stubben (2008) on tax avoidance variable by Desai and Dharmapala (2006). Results show that overinvesting behavior by managersyields a positive coefficient with tax avoidance. Given several tax benefits, such as tax credit, and the accelerateddepreciation method that encourage scorporations to invest in Korea, inefficient investing activities, such as overinvesting, can be usedto avoid the tax burden. This study is significant because itexamined previous studies using empirical analysis, which is limited to the aspect of financial reports as earnings management and management governance.