Effective Tax Rate in European Companies

MASTER OF SCIENCE IN
FINANCE
MASTER´S FINAL WORK

DISSERTATION
EFFECTIVE TAX RATE IN EUROPEAN COMPANIES
AFARIN AHMADI AZARI
November - 2020
MASTER OF SCIENCE IN
FINANCE
MASTER´S FINAL WORK

DISSERTATION
EFFECTIVE TAX RATE IN EUROPEAN COMPANIES
AFARIN AHMADI AZARI
SUPERVISOR:
JOAQUIM MIRANDA SARMENTO
November - 2020
Afarin Ahmadi Azari Effective Tax rate in European Companies
Abstract
This study aims to determine whether firm-specific characteristics have an

influence on the company's effective tax rates. In our study, ETR has been defined
in three ways as following: ETR1 defined as Logarithm of income tax divided by
EBT, ETR2 as logarithm of income tax divided by normalized EBT, and ETR3 as
Logarithm of cash tax paid divided by normalized EBT. The sample consisted of
450 public firms from 18 European countries from eight sectors listed on the Stoxx
Euro 600 from 2002 to 2018. The independent variables used in this study are
company size, leverage, capital intensity, inventory and Profitability jointly whereas
the dependent variable is the company's effective tax rate. The results showed a
negative sign for firm size, Leverage, capital intensity and profitability.
Additionally, it indicated a positive relationship between inventory intensity and
ETRs.
Key words: Effective Tax Rates; Firm size; Leverage; Capital Intensity; Inventory
Percentage; Profitability.
1
Resume
Este trabalho pretende determinar como as características das Empresas têm

influência no consequente tratamento Fiscal, nomeadamente na taxa efetiva de
imposto.
No nosso estudo, a Taxa Efetiva de Imposto (TEI) foi definida das 3 seguintes
formas: TEI1 sendo um logaritmo do rendimento coletável dividido pelo GAI
(Ganhos antes de Impostos), TEI2 sendo um logaritmo do rendimento coletável
dividido pelo GAI normalizado e TEI3 como um algoritmo do montante pago em
Impostos dividido pelo GAI normalizado.
A amostra é constituída por 450 Empresas Publicas de 18 países Europeus e

de 8 diferentes sectores de atividade. Listadas no Stoxx Euro 600 no período de 2012
a 2018.
As variáveis independentes utilizadas foram a Dimensão da Empresa, a

profitabilidade, a Alavancagem Financeira, a "intensidade de capital" e o Inventário,
enquanto que as variáveis dependentes são as Taxas Efetivas de Imposto (TEI).
Os resultados mostram um sinal negativo para a Dimensão da Empresa,

Alavancagem Financeira, Capital Intensivo e Lucratividade. No entanto, mostram
um resultado positivo na relação entre a percentagem de Inventário e a Taxa Efetiva
de Imposto.
Palavras-Chave: Taxa Efetiva de Imposto; Dimensão da Empresa; Alavancagem

Financeira; Capital Intensivo; Percentagem de Inventário; Lucratividade.
2
Acknowledgement
I would like to particularly thank Professor Joaquim Miranda Sarmento for his
valuable supervision and his advices during this research project.
I like to thank my fiancé, my parents, and my sister for their support, without
whose help this work would never have been possible.
3
Table of Contents
Abstract .....................................................................................................................1
Resume …………………………………………………………..…………………2
Acknowledgments .................................................................................................... 3
Table of Contents ...................................................................................................... 4
List of Tables ……………………………………………………………………….5
List of Figures............................................................................................................5
Abbreviations ........................................................................................................... 6
1 – Introduction ........................................................................................................ 7
2 – Literature Review ............................................................................................... 9
2.1 – Firm Size ............................................................................................ 10
2.2 – leverage.............................................................................................. 12
2.3 – Capital Intensity ................................................................................. 12
2.4 – Inventory Percentage ......................................................................... 13
2.5 – Profitability......................................................................................... 14
3 – Methodology .....................................................................................................19
3.1 – Dependent Variable ........................................................................... 20
3.2 – Regression Model .............................................................................. 22
3.3 – Independent Variable ......................................................................... 23
4 – Results ………………………………………...............…………….…….…. 26
4.1 – Hypothesis 1 Firm size and Effective Tax Rates..................................26
4.2 – Hypothesis 2 Leverage and Effective Tax Rates …………………….29
4.3 – Hypothesis 3 Capital Intensity and Effective Tax rate …….......….... 29
4.4 – Hypothesis 4 Inventory Percentage and Effective Tax Rate ..….……29
4.5 – Hypothesis 5 Profitability and Effective Tax Rates.……………..…. 30
5 - Conclusions ........................................................................................................33
References ….......……………………………………………………………..…. 34
4
List of tables
Table I – Literature Review Summary …………………………………………….14
Table II – Data Summary ………………………………………………...………..19
Table III – Descriptive Statistics …………………………………………………..25
Table IV– Correlation Matrix ……………………………………………………..25
Table V – Result of ETR1 ………………………………………………………....28
Table VI – Result of ETR2 ……………………………………………………….. 30
Table VII – Result of ETR3 ……………………………………………………….32
List of Figures
Figure 1: Residuals and Kernel distribution for ETR1 ………….…………..….. 20
Figure 2: Residuals and Kernel distribution for ETR2 ………………….………. 20
Figure 3: Residuals and Kernel distribution for ETR3 …………………….….… 21
Figure 4: Residuals and Kernel distribution for ETR1 (Logarithm) …………...… 21
Figure 5: Residuals and Kernel distribution for ETR2 (Logarithm) ………...…… 22
Figure 6: Residuals and Kernel distribution for ETR3 (Logarithm) ………..……. 22
5
Abbreviations
CAPITAL-INTENS – Capital Intensity
ETRs – Effective Tax Rates
INVENT-PERC – Inventory Percentage
LEV – Leverage
ROA – Return on Assets
SIZE – Firm Size
UK – United Kingdom
USA – United States of America
6
1. Introduction
Effective tax rate has always been an important issue for companies. Hence
determinants of the effective tax rate (ETR) have received much attention among
previous literature during the past decades (e.g., Stickney & McGee, 1982;
Zimmerman, 1983; Shackelford and Shevlin, 2001; Dailimi & Setyowati 2020;
Tijjani and Peter (2020). Quite notable numbers of the determinants of ETR such as
firm size, growth, leverage, foreign operations, legislation change, CEO
performance, ownership structure, capital structure, mix asset, cash flow, CEO
publicity, and board of directors and external auditors’ quality had been studies in
the previous literature (e.g., Bohm, Riedel and Simmler, 2016). This study calls into
question the effects of firm characteristics including firm size, leverage, capital
intensity, capital inventory and profitability on ETR in European countries.
Firm size has been considered as a critical determinant for ETR. As one of the
most mentioned determinants of ETR, firm size has been studied through Political
cost theory and Political power theory. The study of Zimmerman (1983) as one of
the initial works on determinants of ETR, indicated a positive relationship between
firm size and ETR. Many studies after had confirmed their findings, such as Calve-
Perez et al., 2005 and Noor, Fadzillah & Mastuki, 2010; On the other hand, studies
rely on political power theory such as Porcano (1986) showed a negative relationship
between firm size and ETR. Yet, there are studies that showed no significant
relationship between these two or did not consider any of these theories, for example
(Janssen & Buijink, 2000). Besides, there are some studies such as study of Holland
(1998) that found both positive, negative and no significant association between firm
size and ETR due to variety of conditions.
Firm size has received much attention in the last few years and most studies
have mainly focused on its relationship with ETR, until Stickney and McGee (1982)
and later Gupta and Newberry (1997), mentioned the effect of leverage and asset
7
mix (capital intensity) on ETR too. Thereafter, the relationship between leverage
and ETR has received extensive attention both theoretically and empirically in the
literature (e.g., Delgado, Fernandez-Rodriguez & Martinez-Arias, 2014) and similar
to firm size, there was not a corresponding result considering the relationship
between leverage and ETR (e.g., Gupta & Newberry,1997; Plesko, 2003). The
literature shows no consensus on the relationship between asset mix, intensity
percentage nor profitability and ETR in the same way.
Our data collected from Stoxx Euro 600 over the period of 2002-2018 from
Refinitiv. A sample of 450 public firms from 18 European countries were enlisted.
For our first regression OLS we checked fixed effect, for the second regression OLS
year, country and sector effects have been considered, for the third OLS, economic
sector was checked, for the fourth regression OLS we were checked country, for the
fifth regression OLS a Driscoll-Kraay regression were considered and finally for the
last regression OLS multilevel fix effect linear regression has been used.
This paper is organized as follows. The second section gives a brief overview
of literature. the research data is presented in the third section. Section 4 reports and
analyses the data. Our conclusions are drawn in the final section.
As previously mentioned, this paper defined effective tax rates in three ways.
ETR1 was defined as Logarithm of income tax divided by EBT, ETR2 as logarithm
of income tax divided by normalized EBT, and ETR3 as Logarithm of cash tax paid
divided by normalized EBT.
8
2. Literature Review
Determinants of ETR have received much attention over the last decades.
Effective Tax Rates are measure in various way amongst previous studies. There are
several measure of ETRs, that depends on the research question for instance,
Federal, Foreign, State, and Local Income Taxes Payable divided by Pre-tax Book
Income minus the division of Deferred Tax Expense by Statutory Tax Rate by
Stickney and McGee (1982); Income Taxes divided by operating cashflow by
Zimmerman (1983), Current Federal tax expense divided by pre-tax book income
minus equity income from unconsolidated firms plus income from minority interests
by Porcano (1986), the amount of tax paid by a firm in relation to its gross profit by
Harris and Feeny (2000). At the end as mentioned by Harris and Feeny (2000) and
(2003), the definition of ETRs in each research depends on the study question.
Although there are various appropriate equations to measure ETRs, ETRs generally
are measured based on information collected from financial statements as tax
liability divided by income (e.g., Wilkie and Limberg, 1993; Plesko, 2003).
The most studied determinants of ETR in previous works are: firm size,
growth, leverage, foreign operations, legislation change, CEO performance,
ownership structure, capital structure, mix asset, ownership, cash flow, CEO
publicity, and board of directors, political connections, foreign income, and many
more (e.g. Gupta and Newberry, 1997; Holland, Suyono, 2018). As stated in the
Introduction, this study aimed to study the consequences of firm size, leverage,
capital intensity, inventory percentage and profitability on ETRs.
A summary of all the papers that have been cited in this study would be
mentioned later in Table I.
9
2.1 Firm Size
Reviewing literature about determinants of ETRs shows that Firm size has
been studied the most, although the findings are not conclusive. The majority of the
previous studies defined the relationship between firm size and ETR through two
principal theories; Political cost theory and political power theory (e.g., Zimmerman,
1983; Wilkie & Limberg, 1990;). There are still studies that did not find any
significant relationship between firm size and ETR neither through the political cost
theory nor the political power theory (e.g., Stickney & McGee, 1982). In addition to
studies that mentioned different kind of relationship between firm size and ETRs
including positive, negative and not significant (e.g., Holland 1998).
In this regard, the meta-analysis of Belz et al., (2019), supported the stated
conclusions. In a meta-regression analysis, they quantitatively reviewed the
empirical literature on the relation between effective tax rate (ETR) and firm size.
From the 56 primary studies that they reviewed, 20 studies provided evidence for
the political cost theory (e.g., Watts and Zimmerman, 1986), 11 studies provided
evidence for the political power theory (e.g., Gupta & Newberry, 1997), 14 studies
did not support any of these two theories (e.g Stickney & McGee, 1982), and 11
studies provide evidence for both the political cost theory and the political power
theory (e.g., Wu et al., 2012).
According to the political cost theory, there is a positive relationship between
size and ETR (e.g., Omer et al., 1993; Irianto et al., 2017). Watts and Zimmerman
(1986) as the ones who developed Political cost theory, underlined that “Under the
political cost theory, the higher visibility of larger and more prosperous firms causes
them to become victims of greater regulatory actions by the government and wealth
transfers” (Watts and Zimmerman, 1986, p. 235). It means that biggest are the
companies, the greater they suffer from taxation as a result of the greater
governmental control. In other words, due to the political cost theory, firms with
larger sizes have higher corporate effective tax rates.
10
On the other hand, the Political power theory asserted a negative relationship
between firm size and ETR (e.g., Porcano, 1986; Derashid & Zhang, 2003). It means
the bigger the companies are, the greater possibilities they have to diminish taxes.
This statement leads to a negative association between corporate size and ETR.
Wilkie and Limberg (1990) designed a study to recognize the reason of this
conflicting result between study of Zimmerman (1983) and Porcano (1986). They
revealed that this difference could be due to large difference in their sample selection
procedures, ETR definition, firm size measures and date regression techniques.
Additionally, there are studies which did not find any significant relationship
between firm size and ETR such as Wilkinson et al., (2001), Liu & Cao, (2007) For
example, as one of the primitive studies in this context Gupta and Newberry (1997)
through a micro-level longitudinal study showed that in firms with longer histories,
ETRs are not related to firm size.
Amongst studies that supported the relationship of firm size and ETR through
both theories, Wu et al., (2012) in an empirical study suggested that state-controlled
firms political power theory shows a positive relationship between size and ETR,
while privately controlled firms political cost theory explains a negative relationship.
Whereas, for those firms that already enjoy preferential tax status, there is no
significant relationship between size and ETRs (Wu et al., 2012).
Finally, there are studies that have found a nonlinear relation between size and
ETR, which means up to a certain size the relation is positive but from that size on
the biggest companies suffer less fiscal pressure (e.g., Fernandez-Rodriguez &
Martinez-Arias, 2011; Fonseca-Diaz et al., 2011). These studies tried to explain this
inconsistency in literature by defining a non-linear relationship between firm size
and ETR.
Considering the mentioned theoretical perspectives and taking into account
the prior research (e.g., Porcano (1986); Stickney and McGee (1982)). there is a
remarkable inconsistency in the literature studying the effects of Firm size on ETR.
This incompatible result could be due to various determinants such as the
11
geographical areas and firm sector used in each study. Consequently, it can be
mentioned that any relationship between firm size and ETR could be expected. In
this way, our first hypothesis establishes this relationship as follows:
Hypothesis 1: Firm size affects ETR
2.2 Leverage
(1)
After firm size, the relationship between leverage and ETR has received
extensive attention both theoretically and empirically (e.g., Stickney &
McGee,1982; Delgado et al 2014). Like the association of firm size and ETR the
results were not corresponding in previous studies.
There exists a considerable body of literature on the effects of leverage on
ETR suggested a negative relation between leverage and ETR (e.g.; Derashid &
Zhang 2003;; Calve-Perez et al., 2005). While some other studies found a positive
relation between leverage and ETR (e.g., Chen et al., 2010). Meanwhile, there were
studies such as Kim & Limpaphayom (1998), Wilkinson et al. (2001) and Irianto et
al., (2017) that found no significant relation between these 2 variables. Finally, some
studies tried to explain these differences by defining a non-linear relation between
debt and ETR (e.g., Fernandez-Rodriguez & Martinez-Arias, 2011; Delgado et al.,
2012). Due to the unsolid findings of previous studies on the effects of leverage on
ETR, in this study either positive or negative results could be expected. As such,
hypothesis 2 has been established:
Hypothesis 2: Firm leverage effects ETR.
2.3. Capital intensity
In line with the findings of other determinants of ETR that was mentioned
above, the literate predicts a contradistinctive result concerning the relation between
1
In some studies leverage has been named as debt
12
capital intensity (1) and tax burden (e.g., Delgado et al, 2014). A significant number
of empirical studies that investigated Capital intensity as a determinant of ETR,
show a negative relation between these two (e.g., Richardson & Lanis, 2007).
There is also research that showed a direct relation between capital intensity
and ETR (e.g., Janssen & Buijink, 2000; Wilkinson et al., 2001; Wu et al., 2012).
However, some studies did not find any significant relation between these two
variables (e.g., Liu & Cao, 2007; Irianto et al., 2017).
Meanwhile Fernandez-Rodriguez & Martinez- Arias, (2011) and Delgado et
al., (2012) find a non-linear relation between capital intensity and fiscal pressure.
Majority of studies on Europe market revealed a negative relationship between
Capital Intensity and ETRs. Saying that we establish our third hypothesis:
Hypothesis 3: Capital intensity effects ETR negatively.
2.4. Inventory Percentage
Due to our findings, few studies have been published investigating the
relationship between Inventory Percentage and ETR. Among studies that consider
this relationship, there are some that suggesting a positive association between
inventory percentage and ETR such as Gupta and Newberry (1997), Richardson and
Lanis, (2007) and Wu et al., (2012). While some other studies didn’t find any
significant association between these two variables (e.g., Derashid and Zhang, 2003;
Adhikari et al., 2006). In some cases, however, a nonlinear relationship has been
found (e.g., Delgado, Fernandez-Rodriguez & Martinez-Arias, (2018); Drawing on
these previous studies since majority of studies mentioned the positive relationship
between Inventory Percentage and ETR, we formulated the following hypotheses:
Hypotheses 4: Inventory - Intensity has a positive relationship with ETRs.
1
In some studies Capital Intensity has been named as asset mix
13
2.5. Profitability
The contradistinctive disclosure regarding the determinants of ETR continued

in the relation between Profitability and ETR. The empirical studies show a positive
relationship between profitability and ETR (e.g., Richardson & Lanis, 2007; Chen
et al., 2010). Still, some studies for example the ones that specifically investigate
this relation in Malaysia Market and not the USA market revealed a negative
relationship between these two (Derashid & Zhang, 2003; Noor, Matsuki, & Bardai,
2008; Noor et al., 2010). Whereas some studies didn’t find any significant relation
(e.g., Fonseca-Diaz et al., 2011; Irianto et al., 2017). Despite the inconsistency in the
prior research, in this study, a positive relationship between profitability and ETR is
expected. Thus, we formulate our fifth hypothesis:
Hypothesis 5: Firm profitability positively affects ETR.
Table I-Literature Review Summary
Year Name Country Variable Effect
1972 Siegfried N/A Firm size Negative (Political Power Theory)
Firm size Not significant
Leverage Negative
1982 Stickney & McGee USA Capital
Negative
intensity
Profitability Positive
1983 Zimmerman USA Firm size Positive
1986 Porcano USA Firm Size Negative (Political Power Theory)
1986 Watts & Zimmerman USA Firm Size Positive (Political Cost Theory)
Relationship b/w Firm Size and ETR depends on

1990 Wilkie & Limberg N/A Firm size
the empirical procedures
Relationship b/w Firm Size and ETR depends on

1993 Omer et al. N/A Firm Size
the measures
Firm size Not Significant
Leverage Negative
Capital
1997 Gupta & Newberry USA Negative
intensity
Inventory Positive
14
1968-1979: positive relationship between firm size

and ETR
1980-1993: weaker relationship between firm size
1998 Holland UK Firm Size
and ETR
late 1970s and the start of the 1980s: negative

relationship between firm size and ETR
Firm size Negative- Political Power theory

1998 Kim & Limpaphayom Hong Kong
Leverage Not significant
Firm
1999 Buijink, Janssen & Schols EU Not significant
Charactristics
Firm Size Negative

2000 Harris & Feeny Australia
Leverage Positive
Capital
2000 Janssen & Buijink Netherlands Positive
intensity
2001 Gordon & Lee USA Firm Size Positive
Tax and Non-

2001 Shackelford & Shevlin _ Empirical income tax research in accounting
Tax factors
2001 Wilkinson, Cahan & Jones Netherlands Leverage Not significant

Capital
Positive
intensity
The provision of tax incentives differs substantially
Average ETR between EU
2002 Buijink, Janssen & Schols EU from financial
statements Tax incentives do not have the effect of equalizing
actual corporate tax burdens in the EU
Leverage Negative
Capital
2003 Derashid & Zhang Malaysia Negative
intensity
Inventory Not significant
Profitability Negative

2003 Harris & Feeny Australia
Leverage Positive
Leverage Not Significant

Capital
2003 Plesko USA Positive
intensity
2003 Rego USA Firm Size Negative- Political Power theory
Leverage Negative
2004 Fernández-Rodríguez Spain Capital
Not significant
intensity
15
Firm size Positive
Leverage Negative
2005 Calvé-Pérez Serer& Llopis Spain Capital
Negative
intensity
2005 Feeny, Gillman & Harris Australia Leverage Positive

Capital
Positive
intensity
Firm Size Negative- Political Power theory
Vandenbussche, Crabbé & Leverage Positive
2005 Belgium
Janssen
Capital
Negative
intensity
Adhikari, Derashid &
2006 Malaysia Inventory Not significant
Zhang
2007 Liu & Cao China Leverage Negative

Capital
Not significant
intensity
Leverage Negative
Capital
2007 Richardson & Lanis Australia Negative
intensity
Inventory Positive
Firm Size Positive
leverage Negative
2008 Noor, Matsuki & Bardai Malaysia Capital
Negative
Intensity
Leverage Positive
Chen, Chen, Cheng &
2010 USA Capital
Shevlin Negative
intensity
Firm size Positive
Leverage Negative
2010 Noor, Fadzillah & Mastuki Malaysia Capital
Negative
intensity
Firm size Non Linear

Fernandez-Rodriguez &
2011 Martinez-Arias USA & EU
Capital
Non Linear
intensity
16
Fonseca Díaz, Fernández- Leverage Non Linear

2011 Rodríguez & Martínez- Spain Capital
Arias. Negative
intensity
Profitability Not significant
Firm Size Non Linear
Delgado, Fernandez- Leverage Non Linear

2012 Rodriguez & Martinez- USA Capital
Arias Nom Linear
intensity
Fernández-Rodríguez & China &

2012 Profitability Positive
Martínez-Arias USA
Leverage Negative
Capital
2012 Wu, Wang, Luo & Gillis China Positive
intensity
Inventory Positive
2013 Bao &Romeo USA Firm Size Positive
Firm Size Positive (Political Cost Theory)
2013 Huang, Chen, & Gao China Leverage Non-Linear
Inventory Positive
Firm Size
Leverage
2013 Lietz N/A Capital Comprehensive Literature Review
Intensity
Profitability
Firm Size Non-Linear
Leverage Non-Linear
Delgado, Fernandez- Capital
2014 Rodriguez & Martinez- EU Non-Linear
Intensity
Arias
Inventory Non-Linear
Profitability Non-Linear
Firm Size Significant, Different based on country
Leverage Positive
Fernández-Rodríguez &
2014 BRIC
Martínez-Arias Inventory Significant, Different based on country
Profitability Significant, Different based on country
Firm Size Positive
Leverage Negative
2014 Kraft Germany
Profitability Negative (indirectly)
17
Leverage Negative
2014 Lazăr Romania Capital
Negative
Intensity
2016 Bohm, Riedel & Simmler Germany Firm Size Negative
Firm Size Positive
Leverage Negative
Capital
2016 Parisi Italy Negative
Intensity
Inventory Negative
Dyreng, Hanlon, Maydew

2017 USA Firm Size Negative
& Thornock
Firm Size Positive
Leverage Not significant

2017 Irianto, Sudibyo & Wafirli Indonesia Capital
Not Significant
intensity
Profitability Not significant
Delgado, Fernández-
2018 Rodríguez & Martínez- Germany Inventory Non-Linear
Arias
2018 Suyono Indonesia Leverage Negative
Belz, von Hagen &
2019 N/A Firm size Review the empirical literature
Steffens
Firm Size Negative
2020 Dailimi & Setyowati Indonesia Leverage Not Significant
Leverage Not Significant

2020 Tijjani & Peter Nigeria
18
3. Methodology
In order to identify the effects of firm characteristics including firm size,

leverage, capital intensity, capital inventory and profitability on Effective Tax Rate
(ETR) in European countries, the mentioned hypothesis were analyzed in this study.
For the sample, we collected data from Stoxx Euro 600 from Refinitiv during
2002 to 2018. A total of 450 public firms were enlisted from 18 European countries
(1). The firms were categorized in eight various economic sectors (2).
As it can be seen in table I UK had the greatest number of firms in total
followed by France and Germany while Cyprus had the least with only 1 firm in 1
sector. Industrial were the sector with the greatest number of cases and
telecommunication services was the sector with the least.
Table II: Country data review

Basic Material, Consumer Cyclicals, Consumer Non-Cyclicals, Energy, Healthcare, Industrials, Technology, Telecommunication Services Utilities
Austria 2,00 - - 1,00 - 1,00 1,00 - 1,00 6
Belgium 2,00 - 2,00 - 2,00 2,00 - 2,00 1,00 11
Cyprus 1,00 - - - - - - - - 1
Denmark 1,00 1,00 3,00 1,00 7,00 3,00 - - 1,00 17
Finland 3,00 1,00 1,00 1,00 1,00 4,00 1,00 1,00 1,00 14
France 2,00 20,00 6,00 2,00 5,00 21,00 6,00 3,00 3,00 68
Germany 11,00 14,00 3,00 - 9,00 11,00 6,00 4,00 3,00 61
Ireland 2,00 2,00 2,00 1,00 1,00 1,00 9
Italy 3,00 - 1,00 3,00 3,00 5,00 - 1,00 5,00 21
Luxambyrg 1,00 1,00 - 1,00 - 1,00 - - 1,00 5
Netherland 3,00 2,00 4,00 3,00 3,00 4,00 3,00 2,00 - 24
Norway 2,00 1,00 3,00 3,00 - 1,00 - 1,00 - 11
Poland 1,00 - - 1,00 - - - - 1,00 3
Portugal 0,00 1,00 - 1,00 - - - - 1,00 3
Spain 0,00 1,00 - 3,00 1,00 3,00 1,00 2,00 4,00 15
Sweden 4,00 6,00 4,00 1,00 3,00 13,00 2,00 2,00 - 35
Switzerland 5,00 4,00 5,00 1,00 7,00 11,00 4,00 2,00 - 39
UK 10,00 28,00 12,00 5,00 7,00 26,00 9,00 2,00 6,00 105
Total 53,00 82,00 46,00 28,00 49,00 107,00 33,00 22,00 28,00 448,00
1
. Countries: Austria, Belgium, Cyprus, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg,
Netherland, Norway, Poland, Portugal, Spain, Sweden, Switzerland and United Kingdom.
2
. Sectors: Basic Material, Consumer Cyclicals, Consumer Non-Cyclicals, Energy, Healthcare, Industrials,
Technology, Telecommunication Services and Utilities.
19
3.1 Dependent variable
The dependent variable is represented by ETRs. At the first step Effective Tax
Rate (ETR) has been defined through three separate measurement. ETR1 is defined
as income tax divided by earning before tax (EBT), ETR2 is defined of income tax
divided by normalized EBT and ETR3 is defined as cash tax paid, divided by
normalized EBT.
Due to non-normality of residuals, ETR1 could not be considered as income
tax divided by EBT. The result can be seen in the in figure 1. Then ETR2 was
examined and the same problem had happened. Figure 2 are showing this. Non-
normality of residuals has happened the same for ETR3 as it can been seen in figure 3.
Figure 1. Residuals and Kernel distribution for ETR1
20
To solve the mentioned problem, ETR1 has been defined as Logarithm of

𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥
income tax divided by EBT (log ( )), ETR2 as logarithm of income tax
𝐸𝐵𝑇
𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥
divided by normalized EBT (log (𝑛𝑜𝑟𝑚𝑎𝑙𝑖𝑧𝑒𝑑 𝐸𝐵𝑇)), and ETR3 as Logarithm of cash
𝑐𝑎𝑠ℎ 𝑡𝑎𝑥 𝑝𝑎𝑖𝑑
tax paid divided by normalized EBT (log ( )).The results of this new
𝑛𝑜𝑟𝑚𝑎𝑙𝑖𝑧𝑒𝑑 𝐸𝐵𝑇
measurements could be seen in figures 4,5 and 6. These figures provide the Kernel
Density and the Normal Distribution of our explanatory independent variables.
Density is on the y-axis and the studentized residuals are on the x-axis.
Figure 4. Residuals and Kernel distribution in ETR1 (logarithm) for effective tax rate
21
3.2. Regression Model
In order to find the effect of our explanatory variables jointly on effective tax
rate, the regression model has been used by performing simple regression model
using Ordinary Least Square (OLS) method. We performed 6 different OLS. To
begin with, for our first OLS we ran HAUSMAN TEST and the p-value was under
0.1 so the fixed effect has been considered. In the second OLS instead of fixed
effects, year, country and sector effects have been considered. Furthermore, for the
third OLS, all the determinants have been used while we were questioning for
economic sector. In the fourth OLS we were also using all determinants yet
clustering for country. Afterwards, for the fifth regression all determinants have been
22
used but a Driscoll-Kraay regression specifically were considered. Lastly for the
Sixth OLS we used all determinants, even though a multilevel fix effect linear
regression has been used.
Based on the developed hypothesis the following mathematical equation could
be formulated:
𝐸𝑇𝑅 = 𝛼0 + 𝛽 𝑆𝑖𝑧𝑒 + 𝛾 𝐿𝐸𝑉 + 𝛿 𝐶𝐴𝑃𝐼𝑇 + 𝜆 𝐼𝑁𝑉𝐸𝑁𝑃 + 𝜇 𝑅𝑂𝐴 + 𝜀
3.3. Independent variable
As it has been mentioned earlier, FIRM SIZE as our first independent variable
is defined as the logarithm of total assets. The next variable is LEVERAGE that
assumed as the ratio of total debt to the total asset. Then is CAPITAL INTENSITY
as the ratio of a tangible asset to the total asset. Afterwards INVENTORIS has been
considered as the ratio of investment to total lost. Last but not least,
PROFITIBALITY (ROA) assessed as ratio of earning before tax income to total
asset.
Firm size is one the most studied determinant of ETRs, if not the most studied
one. In almost all past literature, independent to the findings, firm size has been
studied through two major theories: Political Power theory (e.g., Siegfried, 1972)
and Political cost Theory (e.g., Watts & Zimmerman, 1986). Belz et al (2019) in a
meta-regression analysis showed the diversity in the finding related to the
association between firm size and ETRs. They revealed that during the last 40 years,
regarding the relationship between firm size and ETRs studies provided evidence
for both the political cost theory, for political power theory, or even no significant
relationship through either theory, still some studies provide evidence for both
theories. In this study, firm size is measured by the logarithm of total assets.
The same as Firm size, Leverage was not free from the inconsistency of
findings among the past literature. As it has mentioned above, positive and negative
23
relationship both were revealed about the relationship of Leverage and ETRs (; Liu
& Cao, 2007;Chen et al., 2010). Still, some studies mentioned that there is no
significant relationship between these two variables. (e.g., Kim & Limpaphayom,
1998; Wilkinson et al., 2001) or a nonlinear relationship (Fernandez-Rodriguez &
Martinez-Arias, 2011; Delgado et al., 2012). In our analysis Leverage is defined as
the ratio of total debt to the total assets as used by for example Chen et al., (2010).
The research on the connection between Capital intensity and ETRs was not
far from the findings related to firm size and Leverage. He same as these other two
variables there were different statement according to the relationship between Capita
Intensity and ETRs. In most used sited articles such as Gupta and Newberry (1997),
a negative relationship between these two variables were found. Meanwhile Wu et
al., (2012) revealed a positive relationship between Capital Intensity and ETRs. In
our analysis, Capital intensity would be measured as the BPE net divided by assets.
Not many studies have been found explaining the relationship between
Inventory Percentage and ETR. Examples of investigating this relationship are,
Adhikari et al., (2006), and Delgado et al., 2018 thought there is no consistency in
their findings. The inventory percentage is the inventory divided by assets.
Not surprisingly and in line with findings of our other dependent variables, an
inconsistency has noted in the relationship between Profitability and ETRs (e.g.,
Fernandez- Rodriguez, 2004; Lietz, 2013). However, here a positive relationship
between profitability and ETR is expected. We defined Profitability or the return on
assets as the EBT divided by assets.
We tested these independent variables for multiclonality. The related
correlation matrix has been showed in table III. As it can be seen, all correlations are
bellow 0.6, however the correlation between depreciations and the log of assets is
close to 0.6. Therefore, it can be said that there could be some multiclonality between
depreciations and the log of assets. Consequently, depreciations have not been used.
We used the WALT test for the three dependent variables. Since the used
logarithm of ETR1, ETR2 and ETR3 test were zero, in has been concluded that all
the regressions are significant in the model. The BREUSCH-PAGAN test was used.
24
It proved (p-value < 0.1) the existence of heteroscedasticity in our data. Therefore,
the standard robust errors were used in our regressions.
The Control variable in our study includes share outstanding, financial crises,
country, year and sector. The descriptive statistic of Mean, standard deviation,
minimum and maximum for all three types of ETR as our dependent variables and
our explanatory variables (Firm size, Leverage, Capital intensity, inventory
percentage and Profitability) are summarized in table II (as followed in results
section).
TableA III: Descriptive statistics
Variable Obs Mean Std. Dev. Min Max

log_etr 4 449 -2,036682 1,128874 -10,34871 3,90838
log_etr2 4 449 -2,144373 1,047467 -10,34871 2,9866
log_etr3 4 449 -1,576852 0,7490263 -8,983064 3,078568
log_assets 4 449 23,03041 1,561629 17,34569 26,88587
lev 4 449 0,1940437 0,1373038 0 1,114315
capital_in~s 4 449 0,2609908 0,2041313 -0,1538729 1,021438
invent_perc 4 449 0,1072759 0,11612 0 0,9597083
roa 4 449 0,0976145 0,1206303 -0,2506526 3,111728
depreciati~s 4 449 9,31E+08 2,28E+09 0 2,45E+10
shares_out~g 4 449 9,71E+08 2,21E+09 217970 3,16E+10
fincrisis 4 449 0,2929137 0,4551431 0 1
Table IV: Correlation Matrix
log_as~s lev capita~s invent~c roa deprec~s shares~g fincri~s

log_assets 1
lev 1
0,0585
capital_in~s 0,1479 0,2642 1
invent_perc -0,2257 -0,4238 -0,2221 1
roa -0,2376 -0,2916 -0,0127
depreciati~s 0,2679 1
0,568 -0,0132
shares_out~g 0,2173 -0,1641
0,3997 -0,023 - 1
0,0712 0,1609
fincrisis -0,1536 0,0221
-0,0245 0,0138 0,4879 1
0,0333 -0,0074 0,0335 0,0155 0,0099 1
25
4. Result
The aim of this study is to examine the effects of firm characteristics (SIZE,
LEV, CAPITAL-INTENS, INVENT-PERC & ROA) on ETR. In order to find out
the effect of these firm characteristics on effective tax rate, the regression model has
been used by performing a simple OLS regression. As previously mentioned, we
measured the effective tax rate in three different way (ETR1, ETR2 & ETR3). We
are going to observe the econometric results obtained through our regression mode.
The results can be found on table IV, V and VI. Consequently, to statistically assess
the determinants of effective tax rate in European countries. Our regressions
revealed that the Explanatory variables of Firm size, Leverage, Capital intensity and
Profitability jointly are significantly associated with ETRs. More details on this will be
given below.
4.1. Hypothesis 1 Firm size and effective tax rate
Regarding our first hypothesis, our tests highlighted a negative relationship

between ETR1 and firm size This result is in line with findings of previous studies,
for example Stickney and McGee (1982), Derashid and Zhand (2003), Richardson
and Lanis (2007). The relationship between firm size and ETR2 has been shown in
table V. Similarly, the result showed a negative relation between firm size and ETR2.
This is in line with our finding regarding the relationship between firm size and
ETR1. In contradiction with earlier findings of ETR1 and ETR2, we found a positive
relationship between ETR3 and firm size. This result is consistent with previous
results of for example, Zimmerman (1983), Plesko (2003).
Due to various reasons as, big firms have superior resources, they are more
involved in profit shifting activities or having more deduction (e.g., Richardson &
Lanis, 2007) it is very likely that bigger firms lower the ETR. In other words, firms
with large assets can save money so that they will be able to pay to shareholders
which could be the reason of positive result in ETR3. This could explain in our
26
negative association between firm size and ETRs in ETR1 and ETR2 versus this
positive association in ETR3.
27
Table V
(1) (2) (3) (4) (5) (6)
VARIABLES log_etr log_etr log_etr log_etr log_etr log_etr
log_assets -0.0733*** -0.0002 -0.0838** -0.0838 -0.0838** -0.0838***

(0.0120) (0.0139) (0.0340) (0.0547) (0.0319) (0.0121)
lev -0.5912*** -0.3966*** -0.6269 -0.6269 -0.6269* -0.6269***
(0.1293) (0.1318) (0.3553) (0.4031) (0.3330) (0.1304)
capital_intens -0.7035*** -0.7853*** -0.6025*** -0.6025** -0.6025** -0.6025***
(0.0845) (0.0947) (0.1594) (0.2166) (0.2355) (0.0846)
invent_perc 0.3136** -0.0462 0.3811 0.3811 0.3811 0.3811**
(0.1522) (0.1550) (0.3633) (0.4548) (0.3205) (0.1534)
roa -4.7149*** -4.9274*** -4.7101*** -4.7101*** -4.7101*** -4.7101***
(0.2520) (0.2557) (0.3237) (0.4164) (0.6523) (0.2535)
shares_outstanding 0.0000*** 0.0000*** 0.0000** 0.0000*** 0.0000*** 0.0000***
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
fincrisis -0.5446*** 0.0378 0.0378 0.0378 0.0378
(0.1188) (0.0283) (0.0745) (0.0413) (0.0354)
Constant 0.3356 -0.8273** 0.5329 0.5329 0.5329 0.5329*
(0.2877) (0.3634) (0.7752) (1.3223) (0.7452) (0.2894)
Fixed effect Yes No No No No No

Country No Yes No Yes No No
Year No Yes No No No No
Sector No Yes Yes No No No
Observations 4,447 4,447 4,447 4,447 4,447 4,447
R-squared 0.0963 0.0923 0.0923 0.0923
Number of year 17 17
Number of groups 17
Table IV – Result of ETR1

This table presents the results of a OLS regression. First regression OLS the checked for fixed effect, the
second regression OLS checked for the year, country and sector effects, the third OLS checked for
economic sector, the fourth regression OLS checked for country, the fifth regression OLS checked for
Driscoll-Kraay regression, the sixth regression OLS checked for multilevel fix effect linear regression
Robust standard errors in parentheses. *** p < 0.01, ** p < 0.05, and * p <0.1.
28
4.2. Hypothesis 2 Leverage and Effective tax rate
Our experiments showed a negative relationship between leverage (debt) and

all 3 ETRs (ETR1, ETR2 & ETR3). Regarding ETR1. Which confirmed a
statistically significant negative relationship between leverage and ETR1. ETR3
corroborated with our findings about ETR1. Our findings appear to be well
substantiated by for example, Plesko (2003), Pérez, Serer and Llopis (2005),
Undoubtedly, firms with higher leverage are expected to have lower ETRs due to
the deductible interest expenditure (e.g. Richardson & Lenis (2007); Wu et al, 2012)
4.3. Hypothesis 3 Capital intensity and ETR
In our third hypothesis we examined the relationship between Capital Intensity

and ETRs (ETR1, ETR2 & ETR3). Not surprisingly, the results showed negative
relationship between Capital Intensity and ETRs. Our findings match well with or
hypothesis and also confirms earlier findings of studies such as Gupta and Newberry,
(1997), and Deashed and Zhang (2003).
4.4. Hypothesis 4 Inventory intensity
Confirming our fourth hypothesis, there was a positive relationship between

inventory percentage with ETRs. Therefore, it can be said that there is a positive
relationship between inventory percentage and ETR2. While table II did not show
any statistically significant results. This substantiates previous findings in the
literature such as Gupta and Newberry (1997), Richardson and Lanis, (2007), etc.
Since inventory intensity is a substitute for capital intensity, it can be reasonably
assumed that firms with greater inventory percentage have lower ETRs.
29
Table VI
(1) (2) (3) (4) (5) (6)

VARIABLES log_etr2 log_etr2 log_etr2 log_etr2 log_etr2 log_etr2
log_assets -0.0547*** 0.0146 -0.0644* -0.0644 -0.0644** -0.0644***

(0.0113) (0.0131) (0.0323) (0.0488) (0.0298) (0.0114)
lev -0.4260*** -0.2664** -0.4682 -0.4682 -0.4682 -0.4682***
(0.1221) (0.1247) (0.3391) (0.3741) (0.3141) (0.1231)
capital_intens -0.6955*** -0.8292*** -0.5966** -0.5966*** -0.5966** -0.5966***
(0.0798) (0.0896) (0.1812) (0.2002) (0.2179) (0.0798)
invent_perc 0.4090*** 0.0907 0.4636 0.4636 0.4636 0.4636***
(0.1437) (0.1466) (0.3490) (0.4208) (0.2989) (0.1448)
roa -3.1152*** -3.1181*** -3.0665*** -3.0665*** -3.0665*** -3.0665***
(0.2378) (0.2419) (0.2026) (0.4063) (0.5727) (0.2393)
shares_outstanding 0.0000*** 0.0000*** 0.0000** 0.0000** 0.0000** 0.0000***
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
fincrisis -0.3592*** 0.0652 0.0652 0.0652 0.0652*
(0.1123) (0.0366) (0.0766) (0.0398) (0.0334)
Constant -0.3924 -1.5241*** -0.2205 -0.2205 -0.2205 -0.2205
(0.2715) (0.3437) (0.7438) (1.1563) (0.6883) (0.2731)

Observations 4,447 4,447 4,447 4,447 4,447 4,447
R-squared 0.0637 0.0595 0.0595 0.0595
Number of groups 17
Table V– Result of ETR2

30
4.5. Hypothesis 5 Profitability
In our last hypothesis, we tested the relationship between ETRs and

Profitability. Interestingly, our findings were consistent with previous findings in
the literature such as Derashid and Zhang (2003), Noor et al., (2008). In line with
their results we pointed to the negative relationship between Profitability and ETRs.
From the table IV we can see the significant negative relationship between
profitability. Alike, the results for ETR2 indicates negative relationship. However,
we couldn’t find any significant results regarding the relationship between
profitability and ETR3. This result have similarities with finding of previous studies
too such as Fonseca Diaz et al., (2011).
As it has been mentioned before regarding the relationship between firm size
and ETRs, a possible explanation for the negative association of profitability and
ETRs may be that the profitable companies can do better tax planning which helps
them to lessen the ETR (Noor et al., 2010; Irianto, Sudibiyo & Wafirli, 2017).
To put it differently, it is now possible to state that firstly the capital intensity
shows the highest statistically significant relationship in ETR1 and ETR2 in all
models and in ETR3 in 4 models. Secondly Profitability, were the most statistically
meaningful variable for ETR1 and ETR2 in all models. In the third place comes firm
size, which were statistically significant in model 4 of ETR1 and ETR 2 and in 5
models for ETR3. Fourthly, leverage shows the most statistically significant in 4
model for ETR1 and in 3 models significant for ETR2 and ETR3.
Last but not least is Inventory percentage with two statistically significant
models for ETR 1 and ETR2.
31
Table VII
(1) (2) (3) (4) (5) (6)

VARIABLES log_etr3 log_etr3 log_etr3 log_etr3 log_etr3 log_etr3
log_assets 0.0404*** 0.0113 0.0386* 0.0386** 0.0386** 0.0386***

(0.0082) (0.0097) (0.0192) (0.0154) (0.0152) (0.0081)
lev -0.3194*** -0.1834** -0.3208 -0.3208 -0.3208 -0.3208***
(0.0885) (0.0921) (0.2343) (0.2617) (0.2399) (0.0886)
capital_intens -0.3057*** -0.4159*** -0.2944 -0.2944* -0.2944 -0.2944***
(0.0562) (0.0634) (0.1619) (0.1427) (0.1745) (0.0559)
invent_perc 0.0159 0.0089 0.0301 0.0301 0.0301 0.0301
(0.1016) (0.1055) (0.1249) (0.1510) (0.1522) (0.1016)
roa -0.0141 0.1582 -0.0122 -0.0122 -0.0122 -0.0122
(0.1695) (0.1764) (0.2606) (0.3833) (0.2587) (0.1693)
shares_outstanding 0.0000 0.0000*** 0.0000 0.0000 0.0000 0.0000
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
fincrisis -0.0479 0.0621** 0.0621** 0.0621** 0.0621***
(0.0820) (0.0197) (0.0232) (0.0231) (0.0238)
Constant -2.3614*** -1.4834*** -2.3446*** -2.3446*** -2.3446*** -2.3446***
(0.1957) (0.2527) (0.4660) (0.3629) (0.3461) (0.1955)

Observations 4,449 4,449 4,449 4,449 4,449 4,449
R-squared 0.0186 0.0192 0.0192 0.0192
Number of groups 17
Table VI – Result of ETR3

32
5. Conclusion
This paper examines the determinants of ETRs in European firms. Our data
was collected from stoxx Euro 600 from 2002 to 2018 from 450 public firms of 18
European countries. We found a significant negative association between firm size,
leverage, capital intensity and profitability and ETRs. On the other hand, this study
indicates a positive relationship between inventory percentage and ETRs. These
findings add to a growing body of literature on effects of firm characteristics on
ETR. Our work clearly has some limitations.
Limitation:
We are aware that our research may have several limitations. The first
limitation is a result of the fact that our sample is collected from public firms hence
we could not include unlisted firms. Second, our date was limited to a number of
European countries. And in Europe only one index had been studied. Third, we could
have collected our data in bigger period of time. We didn’t have data from all the
countries in all of our mentioned years. Nevertheless, we believe our work could be
a starting point for more research on this area considering the consequences of firm
characteristics on ETR in European countries separately, greater timeline and
various indexes. These topics could all be considered for the future work.
33
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Effective Tax Rate in European Companies

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MASTER OF SCIENCE IN

MASTER´S FINAL WORK

EFFECTIVE TAX RATE IN EUROPEAN COMPANIES

AFARIN AHMADI AZARI

MASTER´S FINAL WORK

EFFECTIVE TAX RATE IN EUROPEAN COMPANIES

AFARIN AHMADI AZARI

This study aims to determine whether firm-specific characteristics have an

Este trabalho pretende determinar como as características das Empresas têm

A amostra é constituída por 450 Empresas Publicas de 18 países Europeus e

As variáveis independentes utilizadas foram a Dimensão da Empresa, a

Os resultados mostram um sinal negativo para a Dimensão da Empresa,

Palavras-Chave: Taxa Efetiva de Imposto; Dimensão da Empresa; Alavancagem

2.1 Firm Size

2.3. Capital intensity

2.4. Inventory Percentage

The contradistinctive disclosure regarding the determinants of ETR continued

Table I-Literature Review Summary

Year Name Country Variable Effect

1972 Siegfried N/A Firm size Negative (Political Power Theory)

Firm size Not significant

1983 Zimmerman USA Firm size Positive

1986 Porcano USA Firm Size Negative (Political Power Theory)

Relationship b/w Firm Size and ETR depends on

Relationship b/w Firm Size and ETR depends on

Firm size Not Significant

1968-1979: positive relationship between firm size

late 1970s and the start of the 1980s: negative

Firm size Negative- Political Power theory

Firm Size Negative

Tax and Non-

Firm size Not significant

2001 Wilkinson, Cahan & Jones Netherlands Leverage Not significant

Firm size Negative- Political Power theory

Firm size Negative- Political Power theory

Leverage Not Significant

2003 Rego USA Firm Size Negative- Political Power theory

Firm size Not significant

Firm size Positive

Firm size Not significant

2005 Feeny, Gillman & Harris Australia Leverage Positive

2007 Liu & Cao China Leverage Negative

Firm Size Positive

Firm size Negative- Political Power theory

Firm size Positive

Firm size Non Linear

Firm size Non Linear

Fonseca Díaz, Fernández- Leverage Non Linear

Firm Size Non Linear

Delgado, Fernandez- Leverage Non Linear

Fernández-Rodríguez & China &

Firm size Non Linear

2013 Bao &Romeo USA Firm Size Positive

Firm Size Positive (Political Cost Theory)

2013 Huang, Chen, & Gao China Leverage Non-Linear

Firm Size Non-Linear

Firm Size Significant, Different based on country

Profitability Significant, Different based on country

Firm Size Positive

log_assets -0.0733* -0.0002 -0.0838 -0.0838 -0.0838 -0.0838*

log_assets -0.0547*** 0.0146 -0.0644* -0.0644 -0.0644 -0.0644*

log_assets 0.0404*** 0.0113 0.0386* 0.0386 0.0386 0.0386***