Taxes and Peer Effects

Abstract

A growing literature examines how a firm’s behavior impacts the behavior of its peers. In this paper, we examine how changes in tax paying, and the associated financial reporting, impact a firm’s peers. Changes to tax paying and reporting behavior at other firms within a peer group can be affected by many of the same factors, such as industry-level tax policy changes or audit risk, so we make use of exogenous–to the peer firms–shocks to tax behavior. Following the methodology of Dyreng, Hanlon, and Maydew [2010], we estimate managerial tax avoidance fixed effects and use these to identify tax rate shocks associated with executive turnover. We find that peer firms respond to these shocks by changing their GAAP tax rates in the same direction. The magnitude of the effect corresponds to an approximately 10% response to the average change in peer group GAAP effective tax rates. Our evidence suggests that these peer effects occur only for book, rather than cash, effective tax rates. This finding of a differential response in financial reporting compared to tax payments is consistent with the primacy of earnings-based measures to managers and other capital market participants.

Keywords: effective tax rates, peer effects, taxes

JEL Classification: H25, M41