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Taxes and Financial Constraints: Evidence from Linguistic Cues

53 Pages Posted: 30 Jun 2014 Last revised: 20 Jul 2015

Kelvin Law

Nanyang Technological University (NTU)

Lillian F. Mills

University of Texas at Austin - McCombs School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 2, 2015

Abstract

Using a new measure of financial constraints based on firms’ qualitative disclosures, we find that financially constrained firms — firms that use more negative words in their annual reports — pursue more aggressive tax planning strategies as evidenced by: (1) higher current and future unrecognized tax benefits, (2) lower short- and long-run current and future effective tax rates, (3) increase in tax haven usage for their material operations, and (4) higher proposed audit adjustments from the Internal Revenue Service. We exploit the unexpected closures of local banks as exogenous liquidity shocks to show that firms’ external financial constraints affect their tax avoidance strategies. Overall, the linguistic cues in firms’ qualitative disclosures provide incremental information beyond traditional accounting variables or commonly used effective tax rates to reveal and predict tax aggressiveness, both contemporaneously and in the future.

Keywords: Tax Avoidance, Unrecognized Tax Reserve, Negative Words, Disclosure

JEL Classification: H25, H26, M41, G30

Suggested Citation

Law, Kelvin and Mills, Lillian F., Taxes and Financial Constraints: Evidence from Linguistic Cues (March 2, 2015). Journal of Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2459912

Kelvin Law (Contact Author)

Nanyang Technological University (NTU) ( email )

Nanyang Business School
Singapore, 639798
Singapore

Lillian F. Mills

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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