We examine how investors value tax avoidance (measured as the level of cash effective tax rates [ETRs]) and tax risk (measured as the volatility of cash ETRs), and how these constructs interact to influence firm value. Our results suggest that investors positively value tax avoidance but negatively value tax risk and, most importantly, that greater tax risk moderates the positive valuation of tax avoidance. In additional analyses, we find that contemporaneous measures of tax avoidance and tax risk provide insight into future tax cash flows and that our results hold using GAAP ETR-based measures of tax avoidance and tax risk. Finally, our results are robust to a battery of sensitivity checks including controlling for idiosyncratic and systematic risk, the cost of equity capital, and unrecognized tax benefits in the post-FIN 48 period, among others. Broadly, our findings provide new evidence on how taxes affect firm value and suggest that tax avoidance and tax risk should be considered jointly rather than in isolation.

We examine the effect of CEO narcissism on an especially aggressive form of corporate tax avoidance: tax sheltering. Narcissism is a multifaceted personality trait associated with a sense of superiority and a propensity to engage in questionable behavior. Narcissists feel that they are above the law and are aggressive in pursuing what they believe is theirs. Narcissists also possess heightened motivations to pursue rewards or desirable outcomes while only being weakly motivated to avoid negative outcomes. Consistent with these behavioral tendencies of narcissistic individuals, we document statistically and economically significant effects of CEO narcissism on the likelihood that the CEO's firm engages in corporate tax shelters. Our study contributes to the literature by documenting a mechanism through which the individual personality characteristics of the CEO can affect firm-level tax policies. JEL Classifications: H25; H26; M41.

SYNOPSIS Prior research on CEO narcissism has focused on outcomes related to the CEO's firm. We extend this literature by examining how an important counterparty—the firm's external auditor—responds to a client having a more narcissistic CEO. Compared to other firms, firms with narcissistic CEOs are more likely to exhibit greater inherent risk and control risk. To maintain an acceptable level of audit risk when faced with the heightened risk of CEO narcissism, auditors must do additional work. Consistent with this notion, we find that CEO narcissism has an economically and statistically significant positive effect on external audit fees, indicating that auditors work more, charge a risk premium, or both when auditing a client with a more narcissistic CEO. We also find that firms with narcissistic CEOs are more likely to have internal control weaknesses, which suggests a possible mechanism for why auditors might need to perform more work. This is the first study to provide large-sample real-world evidence on how auditors respond to CEO narcissism and demonstrates the significant effect that executive personality characteristics can have in an audit setting.

We examine the effect of high-quality information technology (IT) on corporate tax outcomes. Using a measure of IT quality constructed from rankings in InformationWeek magazine, we find that firms with high-quality IT are able to achieve both lower and less volatile cash effective tax rates than are other firms. These results suggest that firms with high-quality IT are able to avoid more taxes while simultaneously incurring less tax risk compared to firms with lesser IT systems. We also perform mediation analyses to investigate the channels through which high-quality IT enables effective tax planning. Results of these tests suggest that the most important driver of our findings is timely, reliable information facilitated by high-quality IT. Our study contributes to both the IT and tax literatures by identifying and quantifying the returns to investments in IT in terms of more favorable corporate tax outcomes.

Both practitioners and academics are increasingly focusing their attention on the riskiness of firms’ tax planning activities. In this study, we examine how external auditors respond to tax risk, measured using the volatility of firms’ annual cash and GAAP (Generally Accepted Accounting Principles) effective tax rates. Consistent with the notion that tax risk represents a source of engagement risk that is priced by external auditors, we first document a positive association between audit fees and tax risk incremental to fee premiums arising from tax aggressiveness. We also find that knowledge spillover benefits related to the provision of tax nonaudit services moderate this positive association. In supplemental tests, we provide evidence on additional auditor responses to tax risk. In particular, we document that tax risk is positively associated with both audit report lag and the likelihood of the auditor reporting a tax-related material weakness in the client’s internal controls. Our findings add to the growing literature at the intersection of corporate taxation and auditing, and to the literature distinguishing between the level and riskiness of firms’ tax avoidance strategies.