How Reliably Do Empirical Tests Identify Tax Avoidance?

61 Pages Posted: 6 Dec 2014 Last revised: 22 Dec 2016

Lisa De Simone

Stanford Graduate School of Business

Jordan Nickerson

Boston College

Jeri K. Seidman

University of Virginia - McIntire School of Commerce

Bridget Stomberg

University of Georgia - C. Herman and Mary Virginia Terry College of Business

Date Written: December 16, 2016

Abstract

Can common empirical tests reliably identify tax avoidance? This is an important question because our understanding of the determinants of tax avoidance largely depends on results generated using such tests. We seed Compustat data with three tax avoidance strategies and examine how reliably tests of tax avoidance models using effective tax rates and book-tax differences identify this incremental simulated tax avoidance, holding constant known economic determinants of tax avoidance. We find permanent tax avoidance is more easily detected than deferral strategies, and that financial reporting choices can reduce statistical power. We also conclude that, holding constant other research design decisions, power varies by which proxy is the dependent variable and with the magnitude and pervasiveness of tax avoidance in the sample. We further offer evidence on how research design choices such as sample selection and the approach to handling outliers affect power. We contribute to the literature by using a controlled environment to examine the effectiveness of existing empirical tests.

Keywords: tax avoidance, skewness bias, effective tax rate, book-tax difference

JEL Classification: C150, H25, H26, M41

Suggested Citation

De Simone, Lisa and Nickerson, Jordan and Seidman, Jeri K. and Stomberg, Bridget, How Reliably Do Empirical Tests Identify Tax Avoidance? (December 16, 2016). Rock Center for Corporate Governance at Stanford University Working Paper No. 200; Stanford University Graduate School of Business Research Paper No. 15-5. Available at SSRN: https://ssrn.com/abstract=2534058 or http://dx.doi.org/10.2139/ssrn.2534058

Lisa De Simone

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-3874 (Phone)
650-724-3083 (Fax)

HOME PAGE: http://www.gsb.stanford.edu/faculty-research/faculty/lisa-de-simone

Jordan Nickerson

Boston College ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

Jeri K. Seidman (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

Bridget Stomberg

University of Georgia - C. Herman and Mary Virginia Terry College of Business ( email )

Brooks Hall
310 Herty Drive
Athens, GA 30602-6269
United States

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