Firm Inflexibility and Corporate Tax Avoidance

Abstract

We examine the relationship between operational inflexibility and corporate tax avoidance behavior, focusing on the potential for tax avoidance as a means of preparing for operational shocks. Our analysis reveals a strong positive association between inflexibility and tax avoidance – one standard deviation increase in a firm's inflexibility is linked to a 4.1% decrease in cash effective tax rate. We further show that this relationship is likely causal using an exogenous regulatory credit supply shock. Moreover, we find that this relationship is primarily driven by tax base avoidance (as opposed to tax rate avoidance), and is stronger for firms with volatile cash flows, greater financial constraints, higher institutional ownership, more independent boards, and higher CEO risk-taking. The findings suggest that tax avoidance can create value for firms facing operational challenges, particularly for those with stronger governance mechanisms.

Keywords: Firm Inflexibility, Financial Flexibility, Corporate Tax Avoidance, Banking Deregulation, Value Creation

JEL Classification: g32, h26