Investor Valuation of Tax Avoidance Through Uncertain Tax Positions

Abstract

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 on average positively valuing uncertain tax avoidance, suggesting that tax-related contingent liabilities are viewed very differently from other liabilities. Additional analysis reveals that uncertain tax avoidance that gives rise to permanent (as opposed to temporary) tax savings in firms more likely to retain their uncertain tax positions is driving this positive relation. 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.