The Reputational Costs of Tax Avoidance and the Under-Sheltering Puzzle

Abstract:     
We investigate whether firms and their top executives bear reputational costs from engaging in aggressive tax avoidance activities. Prior literature has posited that reputational costs partially explain why so many firms apparently forgo the benefits of tax avoidance, the so-called “under-sheltering puzzle.” We employ a database of 113 firms that were subject to public scrutiny for having engaged in tax shelters, representing the largest sample of publicly identified corporate tax shelters analyzed to date. We examine the reputational costs that prior research has shown that firms and managers face in cases of alleged misconduct: increased CEO and CFO turnover, auditor turnover, lost sales, increased advertising costs and decreased media reputation. Across a battery of tests, we find no consistent evidence that firms or their top executives bear significant reputational costs as a result of being accused of engaging in tax shelter activities. Moreover, we find no decrease in firms’ tax avoidance activities after being accused of tax shelter activity, and no evidence that high reputation firms avoid engaging in tax shelters in the first place. We conclude that the under-sheltering puzzle does not appear to be explained by reputational costs, even for firms accused of being at the aggressive end of the tax avoidance spectrum.

Number of Pages in PDF File: 55

Keywords: reputation, tax shelters, tax avoidance, under-sheltering

working papers series