Investor and Capital Market Responses to Corporate Tax Strategies – An Experimental Analysis

Abstract

In two experiments, we examine the effect of "aggressive" vs. "responsible" corporate tax strategies on investors’ portfolio choices and capital market prices. With respect to investors' private portfolio choices, we find that investors demand an average premium of 257 basis points to be indifferent between stocks of firms that engage in aggressive tax planning and those that refrain from doing so. However, with respect to equilibrium capital market prices, we do not observe any significant effects of aggressive tax planning, although more than two-thirds of the subjects judge aggressive tax planning to be morally illegitimate. We show that this is because (i) morality is partially crowded out in the capital market environment and (ii) moral clienteles form, i.e., investors who consider aggressive tax planning illegitimate tend not to buy stocks of firms that engage in aggressive tax planning at all. Our results shed light on the previously inconclusive findings on the possible reputation effects of tax planning and point to the limitations of recent tax transparency initiatives.

Keywords: Tax Avoidance, Tax Aggressiveness, Moral in Markets, Legitimacy, Reputation, Crowding out

JEL Classification: G11, G12, G41, H25