Investor Valuation of Tax Avoidance Through Uncertain Tax Positions
54 Pages Posted: 15 Feb 2011
Date Written: January 16, 2011
This paper examines equity investor valuation of tax avoidance achieved through uncertain tax positions. New financial reporting standards require firms to separately disclose their contingent liabilities for tax positions that may be disallowed upon tax return audit. This disclosure provides investors with information about the magnitude of firms‘ tax avoidance activity through uncertain tax positions, or uncertain tax avoidance. I find evidence consistent with investors positively valuing uncertain tax avoidance, suggesting that tax-related contingent liabilities are viewed very differently from other liabilities. My findings are consistent with investors interpreting managers‘ past uncertain tax avoidance as an indicator of future uncertain tax avoidance where the economic benefit of avoidance (i.e., cash tax savings) is expected to be retained, and/or a positive reputation effect associated with uncertain tax avoidance activity. Cross-sectional tests provide some evidence that uncertain tax avoidance is positively valued only in well-governed firms, consistent with investors believing the economic benefit of uncertain tax avoidance does not fully accrue to shareholders when governance mechanisms are weak.
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