Relative Valuation of Alternative Methods of Tax Avoidance

Abstract

This paper examines the relative valuation of alternative methods of tax avoidance. Prior studies find that firm value is positively associated with overall measures of tax avoidance; I extend this research by providing evidence that investors distinguish between methods of tax reduction in their valuation of tax avoidance. The impact of tax avoidance on firm value is a function of tax risk, permanence of tax savings, tax planning costs, implicit taxes and contrasts in disclosures of tax reduction in the financial statements. My empirical results suggest that tax avoidance resulting from stock option tax benefits is positively associated with firm value, accelerated depreciation is not associated with firm value and deferral of residual tax on foreign earnings is negatively associated with firm value. Prior studies that find the positive association between firm value and tax avoidance is attenuated in poorly governed firms suggest the discount results from investor concern of managerial opportunism. Self-serving managers conceal diversion of tax savings from investors under the pretext that aggressive tax positions must be hidden from tax authorities in the financial statements. Under this theory transparent tax reduction methods that are clearly supported by the law should not be discounted by investors of poorly governed firms. However, I find that tax avoidance resulting from transparent stock option tax deductions is discounted in poorly governed firms, while tax avoidance derived from opaque deferral of the residual tax on foreign earnings is not, inconsistent with investors believing that managers are exploiting the compromised information environment associated with complex tax transactions.iii Dedication I dedicate this dissertation to my family. Matt, thanks for the support, sacrifice and understanding along the way. Marlowe, thanks for the perspective and smiles when I needed it most. Mom, Dad, Chris and Steve, thanks for the encouragement and support, both emotionally and financially.iv Acknowledgements First, I thank Dr. Bryan Cloyd, my dissertation chair, for his direction throughout the doctoral program. Thank you for your time and energy over the past four years to get me to this point. I appreciate that you always are able to help me see things in new ways, both from an academic and life standpoint. It was an honor to work with you.

Firm Valuation and the Uncertainty of Future Tax Avoidance

“…Prior studies show that tax planning has positive firm valuation implications (e.g. Wang, 2010;De Simone and Stomberg, 2013;Goh, Lee, Lim, and Shevlin, 2013;Inger, 2013). However, our results indicate that this result becomes insignificant when controlling for the variation in effective tax rates.…”

“…Third, we test the implications of our model and the tax planning score using the market-tobook framework used in prior studies (Desai and Dharmapala, 2009;Wang, 2010;De Simone and Stomberg, 2013;Inger, 2013). Our results show that the tax planning score has a positive effect on the relation between pre-tax earnings and market-to-book value.…”

“…Indeed, the topic has recently generated significant interest in the literature (Wang, 2010;De Simone and Stomberg, 2013;Inger, 2013). We contribute to this debate by building and testing a valuation framework that incorporates two outcome dimensions of corporate tax avoidance strategies: the stability and the level of expected tax rates.…”

“…While there is a large body of research on the determinants of corporate tax avoidance (see, e.g., Mills, 1998;Maydew, 2008, 2010), firm value implications of tax avoidance have only recently attracted academic interest (Desai and Dharmapala, 2009;Wang, 2010;De Simone and Stomberg, 2013;Inger, 2013). The classic theoretical literature on firm valuation (e.g.…”

“…First, we use the level of long-term effective tax rates as measure of tax planning (Desai and Dharmapala, 2009;Wang, 2010;De Simone and Stomberg, 2013;Inger, 2013) and find insignificant results. When controlling for the volatility in tax rates, the level of the tax rate remains insignificant and the volatility is significant.…”