Corporate Tax Avoidance and the Level and Valuation of Firm Cash Holdings
Posted: 5 Aug 2011 Last revised: 1 Apr 2013
A traditional view of tax avoidance (or tax aggressiveness) is that it limits payments made to the tax authorities. A first order implication is that tax avoidance will positively impact firm cash holdings. However, recent research contends that tax avoidance strategies impede the flow of firm specific information and consequently permits managers to divert firm resources. In light of this complementary relation between tax avoidance and rent extraction, it is far from clear whether tax avoidance strategies will yield higher cash holdings or in fact lead to lower cash holdings due to rent extraction. Given that cash is a fungible asset, the risk of rent extraction heightened through tax avoidance strategies can also serve to lower the valuation of firm cash holdings. This paper aims to shed empirical light on these issues. We provide three primary findings. First, we find a negative association between tax aggressiveness and firm cash holdings. We find this association to hold across multiple measures of tax aggressiveness. Second, we find this relation is attenuated for firms with stringent governance structures in place. This finding suggests that stringent governance structures limit the adverse effects of tax avoidance strategies in that it constraints managerial ability to divert firm cash holdings. Finally, we find investor valuation of firm cash holdings is lower for high tax avoidance firms. We again find this relation is attenuated for strong governance firms. Overall, our findings contribute to a growing stream of research which questions whether shareholders benefit from aggressive corporate tax avoidance.
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