The Relationship between Tax Risk and Acquisition Price Premium

Abstract

The objective of this study is to evaluate the extent to which financial-statement based proxies for tax risk (i.e. tax reserves) are associated with purchase price in the context of acquisitions. More specifically, we look at the target’s tax risk (tax positions that increase the uncertainty of future outcomes) in relation to the acquisition premium paid by the acquirer. Consistent with other studies, we utilize the level of a firm’s tax reserves (as reported under FIN 48) as the measure that best captures tax risk. The results display that tax risk has a negative and statistically significant relationship with acquisition premium, suggesting that the bidders pays a lower premium when the target firm has tax reserves on their balance sheet. The result is consistent with the argument that aggressive tax behavior by a target may create a significant liability to the acquirer after the takeover. From these results, we insinuate that the acquirer incorporates tax risk into the merger and acquisition terms.

Keywords: Tax Risk, Acquisition Price Premium, Proxy for Tax Risk

JEL Classification: M400, M490