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Income taxes are a major expense for profitable corporations, often totaling 25% or more of pretax income. This study exploits the market for corporate control to test competing agency-based and risk-based explanations of corporate tax planning. Exploiting the staggered enactment of M&A laws across countries that increased the threat of takeover as an exogenous shock that allows a powerful difference-in-differences design, we find a significant reduction in tax avoidance following the takeover law passage. Our analysis suggests that reduced private benefits consumption (i.e., rent extraction) by management, rather than managerial effort aversion or increased risk concerns associated with aggressive tax strategies, is the likely mechanism through which takeover laws impact tax avoidance. Collectively, our findings extend the literature by highlighting the role of the corporate control market in shaping cross-sectional variation in corporate tax avoidance.

ABSTRACT: We develop a linear corporate tax function where taxes paid are regressed on pre-tax income and an intercept. We show that if the intercept is positive, cash ETRs are a convex function of pre-tax income. We present large-sample evidence consistent with this ETR convexity. Thus, although firms may have stable linear tax functions (i.e., constant parameters in the linear tax model) representing stable tax avoidance behavior, ETRs can change over time because of growth in pre-tax income. Consequently, simply examining changes (or differences) in cash ETRs is nondiagnostic about whether tax avoidance has changed over time (or differs across firms). We illustrate our argument by showing that all of the observed downward trend in cash ETRs documented by Dyreng et al. (2017) can be explained by growth in pre-tax income. The wholesale concern about increased tax avoidance over time might be overstated. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G39; H20; H25; H26.

ABSTRACT We develop a linear corporate tax function where taxes paid are regressed on pre-tax income and an intercept. We show that if the intercept is positive, cash ETRs are a convex function of pre-tax income. We present large-sample evidence consistent with this ETR convexity. Thus, although firms may have stable linear tax functions (i.e., constant parameters in the linear tax model) representing stable tax avoidance behavior, ETRs can change over time because of growth in pre-tax income. Consequently, simply examining changes (or differences) in cash ETRs is nondiagnostic about whether tax avoidance has changed over time (or differs across firms). We illustrate our argument by showing that all of the observed downward trend in cash ETRs documented by Dyreng et al. (2017) can be explained by growth in pre-tax income. The wholesale concern about increased tax avoidance over time might be overstated. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G39; H20; H25; H26.

ABSTRACT: We examine whether employee perceptions of managers and firms fall following tax avoidance news. Using S&P 500 firms and generalized difference-in-differences specifications, we find that tax avoidance news negatively affects employee perceptions of managers and firms. In cross-sectional tests, we find that (1) firms and managers in consumer-facing industries suffer larger employee-related perception changes from tax avoidance news compared to other firms, and (2) well-performing firms and their managers face smaller perception changes than other firms and managers. Overall, our results are consistent with tax avoidance news negatively affecting employee perceptions of managers and firms.

To constrain the use of intangible assets in tax-motivated state income shifting and thus crack down on corporate tax avoidance, many U.S. state governments adopted addback statutes. Addback statutes reduce the state tax benefits that firms can gain from creating intangible assets such as patents. Using a large sample of U.S. public firms, we examine the effect of addback statutes on corporate innovation behavior. First, the adoption of addback statutes leads to a 4.77 percentage point decrease in the number of patents and a 5.12 percentage point decrease in the number of patent citations. Second, the “disappearing patents” resulting from addback statutes have significant economic value. Third, after a state adopts an addback statute, a firm with material subsidiaries in that state assigns fewer patents to subsidiaries in zero-tax states, whereas the number of patents that the firm assigns to the other states does not change. Overall, our findings suggest that addback statutes impede corporate innovation.

Income taxes are a major expense for profitable corporations, oftentimes 25 percent or more of pretax income. This study exploits a setting – the market for corporate control – to test competing agency-based and risk-based explanations of corporate tax planning. Exploiting the staggered enactment of M&A laws across countries that increased the threat of takeover as an exogenous shock that allows a powerful difference-in-differences design, we find a significant reduction in tax avoidance following the takeover law passage. Our analysis suggests that reduced management private benefits consumption (i.e., rent extraction), rather than managerial effort aversion or increased risk concerns associated with aggressive tax strategies, is the likely mechanism through which takeover laws impact tax avoidance. Collectively, our findings extend the literature by highlighting the role of the corporate control market in shaping cross-sectional variation in corporate tax avoidance.

To constrain the use of intangible assets in tax-motivated state income shifting and thus crack down on corporate tax avoidance, many U.S. state governments adopted addback statutes. Addback statutes reduce the state tax benefits that firms can gain from creating intangible assets such as patents. Using a large sample of U.S. public firms, we examine the effect of addback statutes on corporate innovation behavior. First, the adoption of addback statutes leads to a 4.77 percentage point decrease in the number of patents and a 5.12 percentage point decrease in the number of patent citations. Second, the “disappearing patents” resulting from addback statutes have significant economic value. Third, after a state adopts an addback statute, a firm with material subsidiaries in that state assigns fewer patents to subsidiaries in zero-tax states, whereas the number of patents that the firm assigns to the other states does not change. Overall, our findings suggest that addback statutes impede corporate innovation.

Human capital is a key factor in value creation in the modern corporation. Yet the disclosure of investment in human capital is scant. We propose that a company’s online job postings are disclosures made outside of the investor-relations channel that contain forward-looking information that could be informative to investors about future growth. We find that changes in the number of job postings are positively associated with changes in future performance and that this relation is stronger when postings likely represent growth rather than replacement. Consistent with job postings providing new information to the market, investors react positively to changes in the number of job postings. The market reaction to postings is stronger when firms are likely to be hiring for growth rather than replacement and for firms with low labor intensity (and therefore high marginal productivity of labor). This paper was accepted by Brian Bushee, accounting.

Human capital is a key factor in value creation in the modern corporation. Yet the disclosure of investment in human capital is scant. We propose that a company’s online job postings are disclosures made outside of the investor-relations channel that contain forward-looking information that could be informative to investors about future growth. We find that changes in the number of job postings are positively associated with changes in future performance and that this relation is stronger when postings likely represent growth rather than replacement. Consistent with job postings providing new information to the market, investors react positively to changes in the number of job postings. The market reaction to postings is stronger when firms are likely to be hiring for growth rather than replacement and for firms with low labor intensity (and therefore high marginal productivity of labor). This paper was accepted by Brian Bushee, accounting.

We examine whether employee perceptions of managers and firms fall following tax avoidance news. Using S&P 500 firms and generalized difference-in-differences specifications, we find that tax avoidance news negatively affects employee perceptions of managers and firms. In cross-sectional tests, we find that (1) firms and managers in consumer-facing industries suffer larger employee-related perception changes from tax avoidance news compared to other firms, and (2) well-performing firms and their managers face smaller perception changes than other firms and managers. Overall, our results are consistent with tax avoidance news negatively affecting employee perceptions of managers and firms.

We study whether, and more importantly, through what mechanisms, quasi-indexers affect portfolio firms’ tax planning by employing the discontinuity in quasi-indexer ownership around the Russell 1000/2000 index cutoff. Using a regression discontinuity design, we find that higher quasi-indexer ownership leads to greater tax saving. With respect to the mechanisms, we find that the greater tax saving is a result of a focus on improved overall firm performance, not a specific focus on improved tax planning. We further find that the documented tax saving effect is partially due to quasi-indexers’ influences on executive equity incentives, corporate governance, and information environment.

We hypothesize and find evidence consistent with foreign firms being tax-favored acquirers of U.S. targets with greater locked-out earnings because they can avoid the U.S. tax on repatriations. This effect is economically significant; a standard deviation increase in lockout is associated with a 12% relative increase in the likelihood that an acquirer is foreign. We also find evidence that foreign acquirers of the target firms are more likely to be residents of countries that use territorial tax systems, as the tax advantages for a foreign firm acquiring a U.S. target with locked-out earnings are even greater for these acquirers.

This study uses state tax amnesties to examine how firms respond to forgiveness—particularly repeated forgiveness—by a taxing authority. We posit that tax forgiveness programs alter taxpayer perceptions of the probability of detection by enforcers or the probability of future forgiveness programs, either of which could affect future tax aggressiveness. We find that firms headquartered in an amnesty-granting state increase state income tax aggressiveness following the first instance of tax amnesty, relative to control firms in other states. Moreover, we find evidence that tax aggressiveness incrementally increases with each additional repetition of a tax amnesty. Finally, we find that the effect of amnesties on tax aggressiveness is more prominent for small firms, which face less scrutiny and for which the tax aggressiveness measures are less confounded. Our findings suggest that repeated programs of tax forgiveness have increasingly negative implications for corporate tax collections.

We hypothesize and find evidence consistent with foreign firms being tax-favored acquirers of U.S. targets with greater locked-out earnings because they can avoid the U.S. tax on repatriations. This effect is economically significant; a standard deviation increase in lockout is associated with a 12% relative increase in the likelihood that an acquirer is foreign. We also find evidence that foreign acquirers of the target firms are more likely to be residents of countries that use territorial tax systems, as the tax advantages for a foreign firm acquiring a U.S. target with locked-out earnings are even greater for these acquirers.

ABSTRACT Based on Lambert, Leuz, and Verrecchia's (2007) derivation of the cost of equity capital in terms of expected cash flows, we generate a testable hypothesis that relates tax avoidance to a firm's cost of equity capital. Using three broad measures of tax avoidance—book-tax differences, permanent book-tax differences, and long-run cash effective tax rates—to test our hypothesis, we find that the cost of equity is lower for tax-avoiding firms. This effect is stronger for firms with better outside monitoring, firms that likely realize higher marginal benefits from tax savings, and firms with higher information quality. Overall, our results suggest that equity investors generally require a lower expected rate of return due to the positive cash flow effects of corporate tax avoidance. JEL Classifications: G32; H26; M41.

ABSTRACT Based on Lambert, Leuz, and Verrecchia's (2007) derivation of the cost of equity capital in terms of expected cash flows, we generate a testable hypothesis that relates tax avoidance to a firm's cost of equity capital. Using three broad measures of tax avoidance—book-tax differences, permanent book-tax differences, and long-run cash effective tax rates—to test our hypothesis, we find that the cost of equity is lower for tax-avoiding firms. This effect is stronger for firms with better outside monitoring, firms that likely realize higher marginal benefits from tax savings, and firms with higher information quality. Overall, our results suggest that equity investors generally require a lower expected rate of return due to the positive cash flow effects of corporate tax avoidance. JEL Classifications: G32; H26; M41.

ABSTRACT We examine whether internal governance affects the extent of real earnings management in U.S. corporations. Internal governance refers to the process through which key subordinate executives provide checks and balances in the organization and affect corporate decisions. Using the number of years to retirement to capture key subordinate executives' horizon incentives and using their compensation relative to CEO compensation to capture their influence within the firm, we find that the extent of real earnings management decreases with key subordinate executives' horizon and influence. The results are robust to alternative measures of internal governance and to various approaches used to address potential endogeneity, including a difference-in-differences approach. In cross-sectional analyses, we find that the effect of internal governance is stronger for firms with more complex operations where key subordinate executives' contribution is higher, is enhanced when CEOs are less powerful, is weaker when the capital markets benefit of meeting or beating earnings benchmarks is higher, and is stronger in the post-SOX period. This paper contributes to the literature by examining how internal governance affects the extent of real earnings management and by shedding light on how the members of the management team work together in shaping financial reporting quality. JEL Classifications: G32; M40.

ABSTRACT We examine whether internal governance affects the extent of real earnings management in U.S. corporations. Internal governance refers to the process through which key subordinate executives provide checks and balances in the organization and affect corporate decisions. Using the number of years to retirement to capture key subordinate executives' horizon incentives and using their compensation relative to CEO compensation to capture their influence within the firm, we find that the extent of real earnings management decreases with key subordinate executives' horizon and influence. The results are robust to alternative measures of internal governance and to various approaches used to address potential endogeneity, including a difference-in-differences approach. In cross-sectional analyses, we find that the effect of internal governance is stronger for firms with more complex operations where key subordinate executives' contribution is higher, is enhanced when CEOs are less powerful, is weaker when the capital markets benefit of meeting or beating earnings benchmarks is higher, and is stronger in the post-SOX period. This paper contributes to the literature by examining how internal governance affects the extent of real earnings management and by shedding light on how the members of the management team work together in shaping financial reporting quality. JEL Classifications: G32; M40.

We construct a new, parsimonious, measure of disclosure quality-disaggregation quality (DQ)-and offer validation tests. DQ captures the level of disaggregation of accounting data through a count of nonmissing Compustat line items, and reflects the extent of details in firms' annual reports. Conceptually, DQ differs from existing disclosure measures in that it captures the "fineness" of data and is based on a comprehensive set of accounting line items in annual reports. Unlike existing measures, which are usually applicable for a subset of firms or are based on a subset of information items, DQ can be generated for the universe of Compustat industrial firms. We conduct three sets of validation tests by examining DQ's association with variables predicted by prior literature to be associated with information quality. DQ is negatively (positively) associated with analyst forecast dispersion (accuracy) and negatively associated with bid-ask spreads and cost of equity. These associations continue to hold after we control for firm fundamentals. Taken together, results from this battery of validation tests are consistent with our measure capturing disclosure quality.