Tax Avoidance and Equity Pricing: The Importance of Countries’ Legal Institutions and Disclosure Regulations

Posted: 1 Sep 2021 Last revised: 4 Jan 2022

See all articles by Ruiyuan (Ryan) Chen

Ruiyuan (Ryan) Chen

West Virginia University

Sadok El Ghoul

University of Alberta - Campus Saint-Jean

Omrane Guedhami

University of South Carolina - Moore School of Business

Jeffrey Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Yang Yang

West Virginia University

Date Written: August 30, 2021

Abstract

In cross-country research, we examine the importance of tax avoidance to equity pricing, and the role that institutional infrastructure plays in shaping this link. Our theoretical framework generates two predictions. First, investors require higher risk premium compensation for their exposure to insiders’ diversion of corporate resources hidden by obfuscatory tax avoidance activities. Second, stronger country-level legal institutions and disclosure environments mitigate this impact. Analyzing a sample of firms from 59 non-U.S. countries, we report strong, robust evidence that equity financing costs rise when firms take more aggressive tax positions. Additional analysis implies that stricter investor protection institutions and sound disclosure regulation alleviate investors’ concerns about insider diversion, moderating the positive impact of tax avoidance on equity pricing. Collectively, our results suggest that investors recognize the complementarity between insider diversion and tax avoidance in less protective environments. Our evidence has major implications for investors and policymakers.

Keywords: Tax avoidance, cost of equity capital, managerial diversion, institutional environments

JEL Classification: G18, G21, G32, G34, H26

Suggested Citation

Chen, Ruiyuan and El Ghoul, Sadok and Guedhami, Omrane and Pittman, Jeffrey A. and Yang, Yang, Tax Avoidance and Equity Pricing: The Importance of Countries’ Legal Institutions and Disclosure Regulations (August 30, 2021). Available at SSRN: https://ssrn.com/abstract=3914068 or http://dx.doi.org/10.2139/ssrn.3914068

Ruiyuan Chen

West Virginia University ( email )

1601 University Avenue
Morgantown, WV 26505
United States

Sadok El Ghoul (Contact Author)

University of Alberta - Campus Saint-Jean ( email )

Edmonton, Alberta T6G 2R3
Canada
780-465-8725 (Phone)
780-465-8760 (Fax)

Omrane Guedhami

University of South Carolina - Moore School of Business ( email )

Columbia, SC
United States

Jeffrey A. Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

Yang Yang

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States

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