Does Tax Risk Affect Investor Valuation of Tax Avoidance?

Abstract

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.

What are the Drivers of Tax Complexity for Multinational Corporations? Evidence from 108 Countries

“…However, its high relevance gives rise to the assumption that complexity is not only driven by the complexity inherent in the regulations themselves, but also increasingly by the decision power of the tax authorities. This finding corresponds to the growing body of literature on tax risk Drake et al 2017;Guenther et al 2017;Nesbitt et al 2017) which examines the deviation of the final tax burden from the estimated tax burden. Such deviations can be caused, for example, by adjustments resulting from arbitrary decisions of tax officers in tax audits.…”

The impact of corporate tax avoidance on analyst coverage and forecasts

“…Tax risk is conceptually different from tax avoidance, in that the former refers to the volatility of a firm's tax positions across years while the latter refers to the level of a firm's tax position in a particular year (e.g. Guenther et al 2017;Wilde and Wilson 2018;Drake et al 2019). As argued in Sect.…”

“…Tax risk is conventionally defined as the volatility of a firm's tax position over time (e.g. Drake et al 2019). Accordingly, we measure tax risk by the volatility in income tax payments, calculated as the standard deviation of annual effective tax rates over the past five-year period (stdetr).…”

“…First, to explore the impact of firm tax-position volatility on analyst behavior, we construct a measure of tax risk in terms of the standard deviation of a firm's effective tax rates over the previous 5 years (e.g. Guenther et al 2017;Drake et al 2019). Financial opacity is higher for firms with more volatile tax planning activities, making it more difficult for analysts to cover such firms.…”

The Effect of Tax Avoidance and Tax Risk on Corporate Risk

“…This study highlight tax avoidance and tax risk as determinants of corporate risk. Guenther, Matsunaga, & Williams (2013, Drake, Lusch, & Stekelberg (2017) stated that tax avoidance is one of the factors affecting corporate risk. Corporate tax is an expense that must be borne by a company so that the management would attempt to minimize the tax expenses to generate greater net income.…”