What Does Tax Aggressiveness Signal? Evidence from Stock Price Reactions to News About Tax Aggressiveness

54 Pages Posted: 26 Mar 2007

See all articles by Michelle Hanlon

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Joel B. Slemrod

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research (NBER)

Date Written: January 23, 2007

Abstract

We study the stock price reaction to news about tax aggressiveness. We find that, on average, a company's stock price declines when there is news about its involvement in tax shelters, but the reaction is small relative to reactions to other corporate misdeeds. We find some limited evidence for cross-sectional variation in the reaction. For example, the stock price decline is smaller for firms that have good governance which is consistent with the idea that for these firms the news is less likely to trigger concerns about insiders' aggressiveness toward the investors themselves. The reaction is more negative for firms in the retail sector, suggesting that part of the reaction may be a consumer/taxpayer backlash. We also test whether the reaction varies with the market's perception of how tax-aggressive the firm is, using the firm's current effective tax rate as a proxy for the market's beliefs, and find mixed results.

We also explore the stock price reaction to reports of current effective tax rate calculations released by Citizens for Tax Justice. We hypothesize that these reports signal tax aggressiveness without the implications for tax penalties or illegal behavior that tax shelter news carries, and therefore any market reaction represents a pure reputation effect. We find no statistically significant stock price reaction to the reports, suggesting that the negative reaction to tax shelter news is not predominantly a reputation effect.

All in all, our analysis suggests that tax shelter news is viewed as a negative event by the market, although the stock price reaction is much smaller than the reaction to major accounting mishaps.

Keywords: tax shelter, market reaction

JEL Classification: M41, H25, H20, G12, G34

Suggested Citation

Hanlon, Michelle and Slemrod, Joel B., What Does Tax Aggressiveness Signal? Evidence from Stock Price Reactions to News About Tax Aggressiveness (January 23, 2007). Available at SSRN: https://ssrn.com/abstract=975252 or http://dx.doi.org/10.2139/ssrn.975252

Michelle Hanlon (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-668
Cambridge, MA 02142
United States
617-253-9849 (Phone)

Joel B. Slemrod

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Room R5396
Ann Arbor, MI 48109-1234
United States
734-936-3914 (Phone)
734-763-4032 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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