Does Non-Conforming Tax Avoidance Affect Investment Decisions?

Abstract:     
In this paper, we investigate the relationship between firm tax avoidance and firm capital expenditures. In theory, a dollar saved through tax avoidance activities is an immediate extra dollar available for the firm and its shareholders in the current period. We conjecture that firms with high levels of tax avoidance generally have higher new capital expenditures, even if they invest in negative net present value projects. Using a sample of firms with data from 1990 to 2008, we hypothesize and find that firms with higher levels of tax avoidance generally have higher capital expenditures and have higher deviations from expected capital expenditures after controlling for year and industry. In additional we find that firms with higher levels of capital expenditures generally are less likely to underinvest and more likely to overinvest as compared to firms in their industry. We suggest that this is evidence that firms with higher levels of tax avoidance are more likely to grow the firm beyond its optimal size by investing in negative net present value projects. Our further analysis examines the relationship between firm tax avoidance and firm capital expenditures after controlling for corporate governance. Our analysis indicates that firms with poor shareholder protections had higher excess firm capital expenditures and were more likely to overinvest. Overall our results suggest that firms use tax savings from tax avoidance activities and excessively invest those proceeds in new capital expenditures.

working papers series