How Reliably Do Empirical Tests Identify Tax Avoidance?

41 Pages Posted: 6 Dec 2014

See all articles by Lisa De Simone

Lisa De Simone

Stanford Graduate School of Business

Jordan Nickerson

Boston College

Jeri K. Seidman

University of Virginia - McIntire School of Commerce

Bridget Stomberg

Indiana University - Kelley School of Business

Date Written: July 27, 2019

Abstract

Research on the determinants of tax avoidance have relied on tests using GAAP and cash effective
tax rates (ETRs) and total and permanent book-tax differences (BTDs). Two new proxies have
emerged that overcome documented limitations of these proxies: one, developed by Henry and
Sansing (2018), allows for more meaningful interpretation of results estimated in samples that
include loss observations. The other, reserves for unrecognized tax benefits (UTB), provides new
data on tax uncertainty. We offer empirical evidence on how well tests using these new proxies
perform relative to those extensively used in prior research. The paper finds that tests using the
proxy developed by Henry and Sansing (2018) have lower power relative to those using other
proxies across all samples, including a sample that includes loss observations. In contrast, when
firms accrue reserves for uncertain tax avoidance, tests using the current year addition to the UTB
have the highest power across all proxies, samples, and levels of reserves. In the absence of
reserves, tests using the GAAP ETR best detect uncertain tax avoidance, on average. This study
contributes to the literature by using a controlled environment to provide the first large-scale
empirical evidence on how the power of tests varies with the use of relatively new proxies, the
inclusion of loss observations, and the advent of FIN 48.

Keywords: tax avoidance, effective tax rates, book-tax differences, simulated data

JEL Classification: 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? (July 27, 2019). 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

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

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